Sunday, March 11, 2012

Competition Demystified: Chapter 8

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.

The situations involving competitive advantages discussed in the book thus far have involved one dominant firm. The behaviour to be followed by such a firm is relatively straightforward, as discussed in previous chapters. But when two or more companies have similar advantages, strategic behaviour becomes more complex, as the result of strategic actions will be based on the actions of the competition.

The authors provide some tools for determining strategic actions in such cases using hypothetical scenarios involving The Home Depot and Lowe's, two firms with advantages in home-improvement retail. One tool is inspired by the prisoner's dilemma of game theory, and involves a two-by-two matrix which illustrates the payoffs to both The Home Depot and Lowe's under different scenarios (of price, advertising, warranty etc. decisions). The course of events that results in equilibrium (a state in which further action by either company would hurt results, and therefore would not be undertaken), however, is not ideal for both companies as a whole (as it is too competitive).

Therefore, some structural and tactical tools are offered that can legally prevent the erosion of profits through too much competition. Structurally, the companies can try to stay out of each others' markets (e.g. by establishing dominance in particular locales). Customer loyalty programs that reward repeat purchasing (and therefore keep customers tied to one supplier) can also help in this regard. Limits on output capacity also help, as there are no benefits to price cuts if there are no volume advantages that come with them (e.g. safety standards that restrict hours of operation).

Tactical responses involve immediate price matching (so that competitors who undercut do not benefit from volume growth). Selective price matching can actually hurt the aggressor. For example, a bank may match rates on the best customers, but leave the second tier customers to the aggressor. This results in an improved book for the defensive bank and a risky book for the aggressor. Responding with lower prices where the aggressor is strong is also a helpful defense, as the aggressor will be hurt more by price decreases where it has the largest volume of sales.

5 comments:

Anonymous said...

I just have to tell you Barel, you're a moron. You arrogantly keep referring to a Warren Buffett approved college professor as a "beginner" when you yourself are lucky to even produce a 5% averaged annual return. Why you would refer to any of his work like that is beyond any comprehension that I posses. It's arrogant, rude, demeaning, and egotistical and you my friend are a moron. Your article are average at best.

ValueInvestorToday
Jim Hodges
A far greater value investor than you'll ever become.

Frank said...

Jim,

Your comment is completely ridiculous and way off base. There are so many idiotic statements, I am not quite sure where to begin.

Let's start with the beginning. First, you address your comment to Barel. Anyone who has spent even a modicum of time on this website knows that the author's name is Saj Karsan, and that Barel refers to a second person no longer involved in the site. Get your facts straight.

Second (and still in the first sentence), it appears you are calling Saj (or rather Barel) a moron because he refers to Greenwald's Value Investing book as being aimed at "beginners." This lacks even the remotest semblance of logic. If you found Greenwald's book to be difficult to comprehend, then it would seem inappropriate to call someone who had a far easier time with the book a moron, since the facts would suggest that you are less capable of understanding (at least this particular book).

Third, I am not aware of any instance whereby Warren Buffett has given his stamp of approval to a college professor. You seem to be implying some sort of assessment system which Buffett uses for reviewing professors; please provide more details.

Fourth, in your final sentence there is a grammatical error. You state the singular "your article" followed by the plural "are." Again, you do this immediately after calling Saj (or Barel, as the case may be) a moron for the second time. Perhaps it would strengthen your argument if, at the very least, you obeyed the basic rules of grammar.

Finally, I agree fully with Saj that Greenwald's book is an introductory textbook on value investing. Indeed, he uses this book to teach a course called B8399-025: INTRODUCTION TO & LEGENDS IN VALUE INVESTING (http://www4.gsb.columbia.edu/courses/detail?&main.term=Spring&main.instructor=bg7&main.section=025&main.year=&main.um1=11537&main.ctrl=contentmgr.list&main.view=coursedb.detail_catalog). Let's not get confused here: focus on the first two words in the course title. You can go to that website and read the syllabus, which shows the textbooks used in the course. Furthermore, that course is limited to first year students. Calling the book introductory or labeling it a "beginner" text is not only appropriate, it is in fact objectively correct.

In the future, you would be well advised to keep your emotions in check and avoid being belligerent as a result of your own personal inadequacies (especially to those who provide high quality content for free, you feckless idiot).

Frank

juan said...

Jim,
That's an incredibly fatuous comment. Saying that someone's work is for beginners is not an insult - even Nobel laureates write books for beginners.

Saj Karsan said...

Thanks Frank and Juan!

Hi Jim,

To be clear, I'm not calling Greenwald a beginner...far from it! But I am saying if someone is already versed in accounting and finance, Greenwald's Value Investing book is a great one in which to start getting acquainted with value investing.

Your return calculations are off, but your accusations of my being a moron may still be accurate (that questions is at least open to interpretation, unlike return calculations!)

Anonymous said...

Frank,

I'll address each point you've made with the hopes my automatic spell correction doesn't a) encourage spelling errors and b) that I give two sh*** about correcting them.

1. I don't frequent this site. Rather, i am emailed the articles on a daily basic. I was aware that both the names Barel & Saj pertained to this website. I used the name of the website and frankly don't care what name I addressed my message to. I believe it was obvious who the intended recipient was.



2. Whether anyone found Greenwald's book to be difficult isn't the point of the argument. Frankly, there's nothing too terribly difficult about value investing other than the requirement of time. An introductory book into value investing is comprised of subject matters that encourage the reader to how to think about the subject matter. Mary Buffett's work(s) is such an example. There was nothing "beginner" about Benjamin Graham. Greenwald's book was simply another way, simpler if you will, of explanation. There's nothing remotely easy about the subject matter, for example, of how to separate maintenance CapEX & growth CapEX. There's nothing "beginner" about approaching the required percentage of revenue a firm requires to be operational. Two advanced matters he touched on in his book. Although he didn't produce a certainty with either in my opinion, I haven't seen anyone who has either. Since you challenged me, I'll make it clear that my understanding invite value principles has garnered in excess of 6,200% since 2008.

3. Warren Buffett gives lectures to a handful of universities. He's selective on the matter. Bruce Greenwald's class is one of them. There's a video on YouTube in which Buffett explains this process. You're free to research it. I watched it a few years ago. If I find it I'll post it. Since you were unaware of his "stamp of approval" process it should be enlightening for you.

<<"Indeed, he uses this book to teach a course called B8399-025: INTRODUCTION TO & LEGENDS IN VALUE INVESTING...Let's not get confused here: focus on the first two words in the course title. You can go to that website and read the syllabus, which shows the textbooks used in the course. Furthermore, that course is limited to first year students. Calling the book introductory or labeling it a "beginner" text is not only appropriate, it is in fact objectively correct.">>

That's a fine example of circular reasoning skills Frank. If determining whether something "is" or "isn't" was as easy as determine whether it was taught in universities at only the introductory level then I imagine this conversation would be over rather quickly and I would have to concede. However, the book is also extensively used in course: B7399-001: Seminar In Value Investing which apart of their EMBA program in finance. That course, unlike the one you pointed out, is a requirement for an advanced degree. Michael Mauboussin also uses the text in the course he teaches at Columbia, B8313-001: Security Analysis. That too is an MBA program. So, the idea that a book's degree of difficulty can be established from which courses employ the book is rather silly. I argue, instead, that degree of difficulty comes from it's relevance in the marketplace. Ben Graham's quantitative analysis is just as important today as it ever was and to diminish his foundation as being basic is nonsensical.

I would say that if you're that "advanced" in your own mind then you're not simple enough for the value way of thinking.

Like Charlie Munger I piss a lot of people off and still don't care. Have a swell day.

P.S. did I spell good enough for you that time?

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