What Warren Buffett says about Commodity Companies

COMMODITY COMPANIES

Warren Buffett does not like to invest in what he calls commodity companies - companies whose product does not differ from that of competitors in any significant way.

A company like this can be vulnerable to the actions of competitors and have limited power to raise prices to retain their profit position in the light of inflation.

WHAT WARREN BUFFETT SAYS ABOUT COMMODITY COMPANIES

Warren Buffett said this in 1982:

‘[Where] costs and prices are determined by full-bore competition, there is more than ample capacity, and the buyer cares little about whose product or distribution services he uses, industry economics are almost certain to be unexciting. They may well be disastrous.’

Companies are in business for one basic reason. They want to make a profit.

Profitable companies with good management are rewarded in the stock market, because when a company does well, the stock price goes up.  This makes investors happy, including the managers and employees who own shares.

In a poorly managed company, the results are mediocre, and the stock price goes down, so bad management is punished.  A decline in the stock price makes investors angry, and if they get angry enough, they can pressure the company to get rid of the bad managers and take other actions to restore the company's profitability.

A highly profitable company can attract more investment capital than a less profitable company.  With the extra money it gets, the highly profitable company is nourished and made stronger, and it has the resources to expand and grow.

The less profitable company has trouble attracting capital, and it may wither and die for lack of financial nourishment.

The fittest survive and the weakest go out of business, so no more money is wasted on them.  With the weakest out of the way, the money flows to those who can make better use of it.

All employees everywhere ought to be rooting for profit, because if the company they work for doesn't make one, they'll soon be out of a job.  Profit is a sign of achievement.  It means somebody has produced something of value that other people are willing to buy.  The people who make the profit are motivated to repeat their success on a grander scale, which means more jobs and more profits for others.

Facing threats from market forces

Consider a small-town five-and-dime store that saw its business start to erode when the first Wal-Mart moved to town 40 years ago.  Think of the 75 year old family bookstore that started to see fewer customers when the first Barnes & Noble superstore opened at a nearby shopping center.

Even for multigenerational businesses, times change.  Most importantly, the players change, too. All business owners must keep valuation in the back of their minds when they sense that a game-changing company has moved into their marketplace.

But competitors aren't the only market forces that change a company's fortunes.  Look at what outsourcing and more modern technologies have done to established companies.  If they haven't kept up, they have three choices:

• modernise (often though for smaller companies to afford),
• put themselves up for sale (to a market that may not be ready to buy), or
• simply fade away.

Many business owners may not see the end coming, whereas the best valuation professionals do.  Valuation is not all about that final dollar figure; it's about measuring a business's short- and long-term viability as well.  A valuation expert with knowledge of your industry - or access to outsider experts who have that knowledge - is as much a central business advisor as your accountant or attorney.

Growth of Businesses - Competition

Most businesses operate in a competitive situation. This means that they have to consider the activities of other businesses when they make decisions.


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COMPETITION means

• a large number of producers
• new firms can set up in the industry
• firms are knowledgeable about the activities of their competitors.

How do firms compete?

1. PRICE - not too high or too low
2. QUALITY
3. INNOVATIONS e.g. new ideas
4. PROMOTIONS e.g. special offers
5. ADVERTISING
6. BRANDING e.g. creating an image / identity (Nike, Burberry)

Successful competition means that the business may

• Survive in the market
• increase profits
• increase market share
• make more dividends for shareholders

Unsuccessful competition may mean the opposite

ACTION

a. Who are the main competitors in the fast food market in your locality?

b. Consider the fast food outlets near you. How do they compete for customers?

c. Why do you think that competition is good for the consumer? Try to think of 3 reasons.

d. What do you understand by branding (clue Virgin, Nike)? What are the benefits of branding to a business?


SMART THINKING

e. Why does competition force a business to become more efficient?


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