In Warren Buffett’s letter published over the weekend he noted the vital importance of identify companies with good or bad economics. He wrote,
“Over the years, I have made many mistakes. Consequently, our extensive collection of businesses currently consists of a few enterprises that have truly extraordinary economics, many that enjoy very good economic characteristics, and a large group that are marginal. Along the way, other businesses in which I have invested have died, their products unwanted by the public. Capitalism has two sides: The system creates an ever-growing pile of losers while concurrently delivering a gusher of improved goods and services. Schumpeter called this phenomenon “creative destruction.” (Warren Buffett, 2023)
To help us deal with the identification of businesses with “extraordinary economics” or “good economics”, some tools have been developed by those interested in the strategic positioning of firms. I’ll illustrate two today: (1) Porter’s Five Forces and (2) The TRRACK system (for more detail see The Financial Times Guide to Value Investing)
Porter’s Five Forces applied to Coca Cola
We can use Porter’s Five Forces (developed by Michael Porter of Harvard) to consider the competitive position of Coca-Cola’s industry. Porter emphasises that the average returns to companies in an industry are determined, yes, by the amount of rival between direct competitors in that industry, but also by four other power relationships. It might be that suppliers to that industry have a lot of power allowing them to increase prices and achieve high ROCE; or maybe customers hold a lot of power and so can push down price charged by the industry under consideration.
With that, let’s look at the power relationships in the soft drinks industry:
What might change is social acceptability of sugar and caffeine. But then Coca-Cola has positioned itself to benefit from growth in other types of drinks as well as variants of Coke, e.g. sugar-free.
A price war with Pepsi is a possibility. But this has been tried before to the detriment of both firms, so it may not have a high likelihood.
It’s possible that governments/regulators may clamp down on Coca-Cola given its dominance of markets. But we have yet to see that happen to any great extent.
Applying Porter’s five forces to a UK company in which I own shares – Dewhurst.
Dewhurst mostly manufacture push buttons and various fixtures for lifts. They have a large percentage of the world market.
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