Investing legend Warren Buffett is renowned for seeking out monopoly businesses with wide moats that allow them to raise prices unhindered.
For a lot of investors, this monopoly situation is framed as an “investment nirvana”. The promised land, so to speak. Buffett himself admitted as much when he once commented that:
“If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business”.
For me, problems abound from this approach to long-term investing. First off, it’s unsuited to the technological age that we live in.
Rent-seeking businesses can no longer rely upon uninterrupted cash flows when technological change is disrupting not just companies but whole industries.
Perhaps more damaging from a shareholder-return perspective, though, is that owning shares of a monopoly tends to mean owning a culture of inertia and hubris. Unsurprisingly, this leads to underperformance.
Easy profits = complacency
Hailing from Hong Kong, I’ve had a front-row seat to witness one of the best places to run a monopoly unencumbered. That’s been bad news for investors.
From consumer retail – think CK Hutchison Holdings Ltd’s (SEHK: 1) ParknShop and Jardine Matheson Holdings Limited’s (SGX: J36) Wellcome – to banks, such as HSBC Holdings plc (SEHK: 5), as well as the handful of property developers, monopolies exist everywhere.
Poor service and offerings have inevitably led to stagnation, a lack of customer service innovation and no clear business growth.
Shareholders of any of these large conglomerates, such as Swire Pacific Ltd (SEHK: 19), banks or property firms will have seen disappointing (or even negative) returns over the last decade.
In Singapore (where I now live), providers of services that are best known for dominant market share and poor customer service, like Singapore Telecommunications Limited (SGX: Z74), have been below-par investments.
We can say these conglomerates and other firms have been hurt by small total addressable markets (TAMs) in both Hong Kong and Singapore.
Yet this problem isn’t specific to one city or country but a global phenomenon that afflicts all sectors, even in large countries.
Technology not immune
Over in the US, take a look at Alphabet Inc’s (NASDAQ: GOOGL) Google search engine and Facebook Inc (NASDAQ: FB) in the world of online advertising.
No one can argue on the profitability of these business models. Both have had an exceedingly easy time throwing off profits in that space over the past few years.
Through the lens of innovation, though, both have been poor in expanding beyond their core revenue drivers. They’ve been labelled “one-trick ponies” and who could argue with that?
Facebook has been accused of buying up competitors and imitating their offerings – anyone remember Instagram Stories being released shortly after Snap Inc’s (NYSE: SNAP) short videos were making waves?
As a shareholder in companies, I think we should be more willing to celebrate competition. It’s a driver of innovation, a spur to change and a call to action. It acts as a lubricant for sustainable business growth.
Real-life examples can be seen in the retail space in the US. One big reason investors should be bullish on retail giants, such as Walmart Inc (NYSE: WMT), Target Corporation (NYSE: TGT) and Costco Wholesale Corporation (NASDAQ: COST), has been their ability to pivot and adapt to the success Amazon.com Inc (NASDAQ: AMZN) has achieved in the online e-commerce space.
It’s an intensely competitive arena and Amazon’s online dominance has forced all retailers to up their game in terms of omni-channel offerings.
In essence, competition compels companies to adopt “out-of-the-box” thinking, and new ways of doing things, to ensure future growth.
The bottom line is that shareholders of the winning companies in the retail space, Amazon and the others alike, have been rewarded with long-term share price appreciation.
Disclaimer: ProsperUs Head of Content Tim Phillips owns shares of Costco Wholesale Corporation.