Collection: Li Lu - #4 'The Only Constant in Business is Change'

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In this episode, Li Lu was asked how great businesses build its moat and limiting competition?

In this episode, you’ll learn:

  • How can companies create competitive advantage?

  • The only constant of business is change.

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Ok, can I actually talk a little bit about those businesses, I mean, in limiting competition and I think Charlie Munger is the master of this, we’re really interested in moat’s. That is the barriers to entry into the business because it’s keeping people out. That’s going to limit competition. If you think about a moat, there are probably only two elements to that moat. So think of it from the point of view of a company trying to get into the business.

One is economies of scale. How big do you have to get? How big a market share do you have to capture in order to be viable as a competitor? So in automobiles, in the global automobile market, it’s really large. And if you have got 1-2% share, you’re going to be fine. In other markets, like, for example, local distribution of caffeinated soft drinks, you’ve got to get to 20-25% of the market to support the infrastructure that you need and to compete. So the first thing is economies of scale.

The second thing I think and again, I’m sort of thinking about Charlie Munger here, is how hard is it to get that market share? Which is all about customer captivity in a contested environment where unique technology will help you with that and so on. So suppose you’ve got to get to 25% share, we know for caffeinated soft drinks that two tenths of a percent share changes hands every year in a contested market. So to get to 25% you’re talking about a 125-year moat.

Do you do a calculation like that for the companies you’re looking at? Do you look at those two elements explicitly?

LI LU 01:44

Well, that and more. (Laughter)


Ok, then what’s ‘the more’? (Laughter)

LI LU 01:48

Scale is important in there, actually, there is a scale economies in those businesses, not everything actually has a scale economies. So sometimes that scale becomes a counterpoint, they could actually be more difficult to really manage. But in a scale economy, scale does really become a competitive advantage. But the dynamic will change after a certain scale, you mentioned automobiles, that’s an interesting example, you know what happens at different phases of the industry.

The consumer side is also important in a sense that if you have quite a bit of consumer addiction to certain products and brand loyalty, obviously that is important and they’re good for a long time until they’re not good. Things do change. New product categories would come along, and brands get tired and old, and not refreshed. The new generations really don’t like to have the same taste as their parents and grandparents.

So that’s really the most interesting aspect of businesses is, (the) only constant is the constant change. All great business changes over time. And (there’s) absolutely no business that can really maintain that competitive edge for forever. But some of the businesses can really keep it for a very, very long time. And of course, when it changes it’s really upon the management team to be able to really reallocate capital towards those businesses, (that are) actually now enjoying a robust competitive advantage.

Take example with Berkshire. It started out as a lousy business, losing business of textile in New England. And Warren and Charlie’s skill is that they took the last bit of the cash flow and skillfully invested in some other businesses, really on the right side of the trajectory. But over time, some of those businesses began to lose its competitive advantage and then they took that capital and allocated to the ones that – so obviously the management capability of allocating capital also plays a very important role.

And, of course, that the culture of a company in the industry that’s rapidly changing so that you are always a few steps ahead of your competitors, which allows you to always (inaudible) on the edge, that also becomes enduring competitive advantage if that culture endures. So in every specific businesses, what really make them successful are very, very different and they change over time. And so that is the most fascinating aspect of the competitive dynamics and those are the most fascinating aspect of being an investor.

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