A Guided Tour of the Market 3

Business Services

Because the business services sector is so varied, we divide it into three major subsectors based on how companies set up their businesses to make money. Specifically, we look at technology-based, people-based, and hard-asset-based subsectors.

Outsourcing makes sense to many business owners because it usually saves time and money, removes the hassle of dealing with noncore tasks, and allows management to focus on what's really important to the success of their company.

In business services, size does indeed matter. Companies can leverage size to boost both their top and bottom lines. By expanding the range of services offered, companies can increase total revenue per customer. By handling more volume – especially over fixed-cost networks – companies can lower unit costs and achieve greater profitability.

Size impacts the industry through branding as well. Often, brands play a major role in a business outsourcing purchase decision.

In general, technology-based businesses [...] require huge initial investments to set up an infrastructure that can be leveraged across many customers. These huge investments are a barrier to entry for new competitors.

Another desirable characteristic of technology-based businesses is the low ongoing capital investment required to maintain their systems. For firms already in the industry, the huge upfront technology investments have already taken place.

As a result of the high barriers to entry into technology-based businesses and long-term customer contracts, firms in this subsector tend to have wide, defensible moats.

The people-based subsector includes companies that rely heavily on people to deliver their services, such as consultants and professional advisors, temporary staffing companies, and advertising agencies. Investments can be attractive at the right price, but the model is generally less attractive than that of the technology-based subsector.

Brands, longstanding relationships with customers, and geographic scope can provide some advantages relative to competitors. But within most people-based industries, there are usually multiple competitors with similar strengths in these areas, and they tend to compete aggressively with one another.

Companies in the hard-asset-based subsector depend on big investments in fixed assets to grow their businesses.

http://books.danielhofstetter.com/the-five-rules-for-successful-stock-investing/

It is easier to make money in some industries than in others.

It is easier to make money in some industries than in others.

Some industries lend themselves to the creation of economic moats more so than others.

These are the industries where you will want ot spend most of your time.

The economics of some industries are superior to others.

You should spend more time learning about attractive industries than unattractive ones.

Every industry has its own unique dynamics and set of jargon.

Some industries (such as financial services ) even have financial statements that look very different from others.

Wade through the different economics of each industry and understand how companies in each industry can create economic moats - which strategies work and how you can identify companies pursuing those strategies.

Here are some areas of the market that are definitely worth more of your time exploring.

• Banks and Financial Services
• Business Services
• Health Care
• Media

These are not the four areas of the market with worthwhile investments.

They are highlighted because they contain so many wide-moat companies.

There are great firms in even the least likely areas of the stock market.

The goal is to help answer a few essential questions:

• How do companies in this industry make money?
• How can they create economic moats:
• What quirks does this industry have that an investor should know about?
• How can you separate successful from unsuccessful firms in each industry?
• What pitfalls should you watch out for?

Over the long haul, a big part of successful investing is building a mental database of companies and industries on which you can draw as the need arises.

That will make you a better investor.

Investor's Checklist: Business Services

Understand the business model.  Knowing if a company leverages technology, people, or hard assets will provide insight as to the kind of financial results the company may produce.

Look for scale and operating leverage.  These characteristics can provide significant barriers to entry and lead to impressive financial performance.

Look for recurring revenue.  Long-term customer contracts can guarantee certain levels of revenue for years into the future.  This can provide a degree of stability in financial results.


Focus on cash flow.  Investors ultimately earn returns based on a company's cash-generating ability.  Avoid investments that aren't expected to generate adequate cash flow.

Size the market opportunity.  Industries with big, untapped market opportunities provide an attractive environment for high growth.  In addition, companies chasing markets perceived to be big enough to accommodate growth for all industry participants are less likely to compete on price alone.

Examine growth expectations.  Understand what kind of growth rates are incorporated into the share price.  If the rates of growth are unrealistic, avoid the stock.  



Ref:  The Five Rules for Successful Stock Investing by Pat Dorsey



Read also:
Investor's Checklist: A Guided Tour of the Market...

How to analyze the market? Business Services

While the companies in our business services sector operate in relative obscurity, the sector deserves more attention. Here, we can find a large number of firms running wonderful, wide-moat businesses - just the kind we like to buy at the right price and hold as long-term investors.

Companies in the business services sector are as varied as the businesses they serve. After all, the group include firms such as Fiserv (financial institution data processing), Waste Management (waste hauling), Omnicom (advertising), and even United Airlines (air transportation). Because the business services sector is so varied, we divide it into three major subsectors based on how companies set up their businesses to make money. Specifically, we look at:

1. technology-based
2. people-based, and
3. hard-asset-based subsectors.

Although not all companies within the industry fit perfectly into just one of these categries, it's a useful distinction to make when you're analyzing a potential investment in business services. Despite being such diverse group of businesses, a few major themes impact the majority of business services companies.

Outsourcing Trend

Business-to-business services have grown significantly, increasing as a percentage of GDP from 3.5 percent in 1990 to 5.4 percent in 2001. Fueling the growth has been the popularity of outsourcing - the practice of offloading noncore tasks to third parties.

Many business services providers have essentially created markets for themselves based on this trend. Cintas, for example, has successfully convinced companies tha it's better to pay Cintas to service employees' uniforms than to leave the responsibility to each individual employee or to handle it themselves. Other industries developed to fill needs that would be difficult or impossible for companies to handle internally. It is impractical, for example, for every mom-and-pop retailer to develop its own infrastructur to facilitate its acceptance of credit and debit card payments. Instead, companies such as First Data and National Processing allow retailers to tap into larger systems, the fixed costs of which can be leveraged across many clients.

Outsourcing makes sense to many business owners because it usually saves time and money, removes the hassle of dealing with noncore tasks, and allows management to focus on what's really important to the sucess of their company.

Economic Moats in Business Services.

In business services, size does indeed matter. Companies can leverage size to boost both their top and bottom lines. By expanding the range of services offered, companies can increase total revenue per customer. By handling more volume - especially over fixed-cost networks - companies can lower unit costs and achieve greater profitability.

To capitalize on this, many business services firms have attempted to acquire their way to critical mass and achieve scale economies by consolidating the operations of multiple businesses. For example, data processing firms such as Fiserv, First Data, and ADP have all made acquisitions an important part of their overall strategies.

Size impacts the industry through branding as well. Often,brands play a major role in a business outsourcing purchase decision. Companies amy be hesitant to utsource payroll processing (and the related handling of employee pay and tax funds) to Fly-By-Night Upstart, Inc., but are comfortable entrusting the responsibility to ADP, founded in 1949 and currently the biggest payroll processor. Even in business services, brands count, and it's usually the biggest companies that have the most recognizable brands.

Many industries in business services have significant barriers to entry, making it tough for new players to enter the field. For example, a company that wanted to process credit card transactions for banks and retailers would have to build a processing infrastructure to support its business, including hardware, the software development to manage the data, and a sales network to sign customers. Such a company would have to go through considerable trouble and expense just to try to compete against a company such as First Data, which already handles billions of transactions each year.

Despite the relatively high barriers to entry in th electonic transaction processing industry, their's little protection against competition from other industry participants. For example, in 2001, Concord EFS lost Bank of America's electronic funds transfer switching business to a very aggressive bid from competitor Visa. Thus, although most business services industries have wide moats, companies still need to differentiate themselves further to fend off potentially intense competition from established industry players.