Business Checklist

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ASK THE RIGHT QUESTIONS - Every business will have its unique powerpoint
LEADERSHIP
Is the CEO self-promoting?
Does the management have a determination to continue to develop products or processes that will still further incr
currently attractive product lines have largely been exploited?
Does the management talk freely to investors about its affairs when things are going well but “clam up” when troub
Does the company have a management of unquestionable integrity?
A CEO who doesn't perform is frequently carried indefinitely. One reason is that performance standards for his job
be waived or explained away, even when the performance shortfalls are major and repeated. At too many compan
then hastily paints the bullseye around the spot where it lands.
CEO has no immediate superior whose performance is itself getting measured. The sales manager who retains a bu
himself. It is in his immediate self-interest to promptly weed out his hiring mistakes. Otherwise, he himself may be
faces the same imperative. But the CEO's boss is a Board of Directors that seldom measures itself and is infrequent
A good managerial record (measured by economic returns) is far more a function of what business boat you get int
effort help considerably, of course, in any business, good or bad)
When a management with a reputation for brilliance tackles a business with a reputation for poor fundamental eco
How would you evaluate this business if you were to become its CEO?
Does the CEO manage the business to benefit all stakeholders?
Does management think independently and remain unswayed by what others in their industry are doing?
To become more successful, a firm needs a leader with a determined entrepreneurial personality combining the dr
fortunes of the firm.
Attention must be paid to attracting competent managers at lower levels and to training them for larger responsibi
pool. The need to recruit the chief executive from outside is a particularly dangerous sign
The entrepreneurial spirit must permeate the organization.
1. Is management rational?
2. Is management candid with the shareholders?
3. Does management resist the institutional imperative?
In evaluating people, you look for three qualities: integrity, intelligence, and energy. If you don’t have the first, the
Are any of the key members of the company’s management team going through a difficult personal experience tha
their shareholders? Also, has this management team previously done anything self-serving that appears dumb?
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R&D
Does the comapany have products and services with sufficient market potential to make possible a sizable increase
People don’t buy products but uses of product
Growth should not be judged because of one year but by units of several years
Two kind of companies - fortunate and able (Alcoa) & fortunate because they are able (DuPont)
Correctly judging the long range sales curve of a company is of extreme importance
A franchise as a company whose product or service (1) is needed or desired, (2) has no close substitute, and (3
How effective are the company’s research and development efforts in relation to its size?
Companies vary a lot in what they include as R&D expense and what they exclude
Necessary to have leaders who can coordinate the skills of different experts
Close relationship between research, production and sales
Coordination skill of top management - would they abandon research projects
Does the company benefit from low margin government contracts whose know how can be transfered to high
Does the company do worthwile market research
Competitive destruction-You know, you have the finest buggy whip factory and all of a sudden in comes this little h
whip business is dead. You either get into a different business or you're dead - you're destroyed. It happens again a
"Surfing" - when a surfer gets up and catches the wave and just stays there, he can go a long, long time. But if he ge
Since Croesus was the supremely rich king of Lydia (modern day Turkey), the question is what would you do if mon
A firm must have a strong enough customer orientation to recognize changes in customer needs and interests and
manner. This capability should lead to generating a flow of new products that more than offset lines maturing or be
Even nontechnical firms today require a strong and well-directed research capability to (a) produce newer and bett
efficient way
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STRATEGY
Can company increase prices to pass cost increases to customers
Excess capacity can curtail the ability to pass price increase to customers
Are there other aspects of the business somewhat peculiar to the industry involved which will give the investor imp
relation to its competition
Company must have other source of competitive advantage rather than patent protection
Engineering that is constantly improving the product is far more valuable than patent protection
To be a truly conservative investment, company must be a low cost producer
Favored business must have two characteristics: (1) an ability to increase prices rather easily (even when product d
significant loss of either market share or unit volume, and (2) an ability to accommodate large dollar volume incre
growth) with only minor additional investment of capital.
Strong preference for businesses that possess large amounts of enduring Goodwill and that utilize a minimum of ta
Businesses logically are worth far more than net tangible assets when they can be expected to produce earnings on
The capitalized value of this excess return is economic Goodwill.
Consumer franchises are a prime source of economic Goodwill. Other sources include governmental franchises not
an enduring position as the low cost producer in an industry.
True economic Goodwill tends to rise in nominal value proportionally with inflation
Any unleveraged business that requires some net tangible assets to operate (and almost all do) is hurt by inflation.
Leaving the question of price aside, the best business to own is one that over an extended period can employ large
capital at very high rates of return. The worst business to own is one that must, or will, do the opposite-that is, con
rates of return. Unfortunately, the first type of business is very hard to find: Most high-return businesses need rela
benefit if it pays out most of its earnings in dividends or makes significant stock repurchases.
Time is the friend of the wonderful business, the enemy of the mediocre
Invert always invert - think what can go wrong with the business - and avoid it
I can’t understand what I can't recreate - Munger on Coke
Cognition misled by tiny changes involving low contrast will often miss a trend that is destiny
Just as in an ecosystem, people who narrowly specialize can get terribly good at occupying some little niche. Just as
the business world - and get very good because they specialize - frequently find good economics that they wouldn'
In terms of which businesses succeed and which businesses fail, advantages of scale are ungodly important.
One great advantage of scale taught in all of the business schools of the world is cost reductions along the
in more and more volume enables human beings, who are trying to improve and are motivated by the ince
The very nature of things is that if you get a whole lot of volume through your joint, you get better at proce
lot to do with which businesses succeed and fail
If you were Proctor & Gamble, you could afford to use this new method of advertising. You could afford the
selling so damn many cans and bottles. Some little guy couldn't. And there was no way of buying it in part.
volume, you couldn't use network TV advertising - which was the most effective technique
Your advantage of scale can be an informational advantage. If I go to some remote place, I may see Wrigley
that Wrigley is a satisfactory product, whereas I don't know anything about Glotz's. So if one is $.40 and the
put it in my mouth - which is a pretty personal place, after all - for a lousy dime?
In some businesses, the very nature of things is to sort of cascade toward the overwhelming dominance of
practically no city left in the U.S., aside from a few very big ones, where there's more than one daily newsp
Another advantage of scale comes from psychology. The psychologists use the term "social proof". We are
- by what we see others do and approve. Therefore, if everybody's buying something, we think it's better. W
Try to compete with a company that has an established distribution network. It has likely covered its fixed c
profits as it delivers more stuff, while you'll need to take on large losses for a time until (if) you gain enough
There are also disadvantages of scale. For example, we - by which I mean Berkshire Hathaway - are the larg
publications there that got murdered - where our competitors beat us. And the way they beat us was by go
Another defect of scale - flush, fat, stupid bureaucracy
in [a] rapidly globalizing world... with uncertain economic and political forecasts... And with increasingly he
rapid change favor flexibility and adaptability over sheer scale.
Can you describe
what thehow the business
customer’s worldoperates,
would look in like
yourwithout
own words?
the product or
service
Use an analogy to describe how the business operates
What is the business doing that the competitors are not doing yet?
How does the business make money?
If you can’t understand how a business makes money, then you should not invest in it.
How hasbusiness
the business evolved
evolved over acquisitions
by noting time? made and new product
developments from year to year.
In what foreign markets does the business operate, and what are the risks of operating in these countries?
How Long Has the Business Been Operating in the Foreign Market?
Is the Business Investing in R&D to Adapt Its Products to the Specific Tastes of the Customers in a Foreign M
Has the Management Team Assigned a Specific Regional Manager to Emerging Markets?
Is Revenue Growth Translating into Profit Growth?
What Are the Risks to a Company’s Foreign Earnings? - Country risk, currency risk,
Who is the core customer of the business?
Is the customer
A businessbase concentrated
that or diversified?
earns its revenues from a diversified customer base
has less risk than one with a concentrated customer base.
Is it easyhigh-
or difficult to convince
pressure customers
sales tactics to buy
to sell their the products
products or services?
or services typically do not have sustainable business mod
for the customer.
What is the customer retention rate for the business?
Customers who enroll in loyalty programs are typically repeat customers
Whether a business is selective about the types of customers it will do business with.
What are the signs a business is customer oriented?
How doesif management
Find out stay close
the business solves to customers?
customer problems quickly
and easily.
What pain does the business alleviate for the customer?
To what degree is the customer dependent on the products or services from the business?
If the business disappeared tomorrow, what impact would this have on the customer base?
Does the business have a sustainable competitive advantage and what is its source?
1. Network economics
2. Brand loyalty
3. Patents
4. Regulatory licenses
5. Switching costs
6. Cost advantages stemming from scale, location, or access to a unique asset
Does the business operate in a good or bad industry?
To beginisevaluating
If there the industry,
a broad range compare
of ROIC, with somethe distribution
companies of returns
doing well andon invested capital
some
To getdoing poorly,
a deeper this is a tougher
understanding industry
of whether antoindustry
be in. is good
or bad, compare the best companies to the worst within the industry.
How has the industry evolved over time?
What is the competitive landscape, and how intense is the competition?
Does the Business Have Limited Competition?
Does the Industry Change Often?
How Do the Competitors Compete within an Industry, and How Could That Change?
How Fiercely Do Businesses Compete?
What Risks Does the Business Face from Substitute Products?
Can Competition from Low- Cost Countries Impact the Business?
Which Competitor Sets the Industry Standard?
Why Have Competitors Failed in an Industry?
What type of relationship does the business have with its suppliers?
Does the Business Have Reliable Sources of Supply?
Is the Business Dependent on Only a Few Suppliers?
Is thebecause
Businessyou
Dependent
must assumeon Commodity Resources,
a certain price for theand to What in
commodity Degree?
the
future.
What are the fundamentals of the business?
What are the key risks the business faces?
How does inflation affect the business?
To what degree is the business cyclical, countercyclical, or recession-resistant?
Does the business grow through mergers and acquisitions (M&A), or does it grow organically?
What is the management team’s motivation to grow the business?
Has historical growth been profitable and will it continue?
What are the future growth prospects for the business?
How does management make M&A decisions?
Have past acquisitions been successful?
Creating value not beating rivals is at the heart of competition
In an unregulated commodity business, a company must lower its costs to competitive levels or face extinction.
In a business selling a commodity-type product, it's impossible to be a lot smarter than your dumbest competi
If rivalry is intense companies compete away the value they create - in lower prices or higher costs of competi
Are their many competitors roughly equal in size
Slow growth promotes battle over market share
High exit barriers - excess capacity can lower profitabiliy
Rivals who are irrationally commited to the business
Price competition is the most damaging form of rivalry - you are competing to be the best. It happens when
Undifferentiated offering and low switching cost
High fixed cost and low marginal cost - creating pressure to drop prices as every new customer will cons
Capacity must be added in high increments - creating supply demand misbalance
Product that is perishable - e.g airline seats
If you have competitive advantage it means you compete at lower prices or premium price or both
Any Cumulative Advantage? - like a relationship
The two types of competitive advantage in the business world are created by producing a unique product and by pr
years from now and has been selling for past 10 years
Three basic types of businesses with durable competitive advantages:
1. Businesses that fulfill a repetitive consumer need with products that wear out fast or are used up
quickly, that have brand-name appeal, and that merchants have to carry or use to stay in business. This is a
huge world that includes every thing from cookies to panty hose.
2. Businesses that provide repetitive consumer services that people and businesses are consistently in need
of. This is the world of tax preparers, cleaning services, security services, and pest control.
3. Low-cost producers and sellers of common products that most people have to buy at some time in their
life. This encompasses many different kinds of businesses from jewelry to furniture to carpets to insurance.
Second- level thinking is deep, complex and convoluted. The second level thinker takes a great many things into acc
• What is the range of likely future outcomes?
• Which outcome do I think will occur?
• What’s the probability I’m right?
• What does the consensus think?
• How does my expectation differ from the consensus?
• How does the current price for the asset comport with the consensus view of the future, and with mine?
• Is the consensus psychology that’s incorporated in the price too bullish or bearish?
• What will happen to the asset’s price if the consensus turns out to be right, and what if I’m right?
A textile company that allocates capital brilliantly within its industry is a remarkable textile company-but not a rem
Getting the story is easier if you understand the basic business. The simpler it is, the better. "An idiot could run this
running it.
1) It sounds dull, or even better, ridiculous-The perfect stock ought to have a perfectly boring name.
2) It does something dull- It does something boring, like make cans and bottle caps.
3) It does something disagreeable - A stock that makes people shrug, or turn away in disgust is ideal.
4) It's a spin off - The institutions don't own it, and the analysts don't follow it
5) The rumors abound: It's involved with toxic waste and/or the mafia
6) There's something depressing about it
7) It's a no-growth industry
People have to keep buying it
user of technology - as technology is advanced and becomes cheaper, costs are reduced
If you find a stock with little or no institutional ownerships, you've found a potential winner. Find a company that n
knowing about, and you've got a double winner.
For every single product in a hot industry, there are a thousand MIT graduates trying to figure out how to make it c
coupon-clipping services, oil-drum retrieval, or motel chains.
Niche means there is little or no competition. People can buy jewelery from anywhere - internet, out of state, acros
franchises are a niche, they have value. You can raise the price with an exclusive franchise. Newspapers used to be
niches, since no one else can make their drug. Chemical companies have niches because getting a poison approved
Marlboro.
In general, corporate insiders are net sellers, and they normally sell 2.3 shares to every one share that they buy. Wh
minimum, the company will not go bankrupt in the next six months. Long term,when management owns stock, the
significant when employees at lower echelons add to their positions. if you see someone with a $45,000 annual sal
meaningful vote of confidence
Depending on the pace of growth or the timing of business cycle, companies can be grouped into 6 categories. The
Slow Growers: Big companies that grow at a very minimal rate. The only reason to keep them is for the regular divi
Stalwarts: Big companies that grow faster than a Slow Grower but not as rapidly as a Fast Grower. They are less vol
downturn.
Fast Growers: These are small companies that grow at a high rate. You make money in stock market if you are able
growth peaks, a Fast Grower either turns to a Stalwart or fizzle out.
Turnarounds: These are companies that have gone through a series of negative events and which are bouncing bac
ground very quickly. In addition the ups and downs of these companies are totally unrelated to the market conditio
Cyclicals: The fortune
of these cyclicals may be big companies and could easily be confused with Stalwarts. However what differentiate cy
conditions, companies like TISCO, Auto makers, Banks, Infra companies like L&T and most of the Industrials like Cro
important to know when to get in to these stocks and when to get out of them.
Asset Plays: These are companies holding significant assets in their books of which the market is not aware of. Som
Carry forward losses which provide tax benefits to the company, Investments in the shares of other companies, hug
'Two minute drill'. Take two minutes of your time and make a case as to why you are interested in the company an
a sound case for investing in the specific stock. The author recommends us to follow this process even for the stock
Never investment in any idea you can’t illustrate with crayons
“If you like the store, chances are you’ll love the stock.” In other words: Invest in businesses you understand and w
The problem with good industries are that they attract competition. These new market participants crave a piece o
pressure. Peter’s binoculars are thus directed at terrible industries. Next, he attempts to find the ‘winner’ in said in
hence enabling them to ride-out cyclical waves while the competitors throw in the towel. Once the industry betters
dead companies’ market shares.
During the Gold Rush, most would-be miners lost money, but people who sold them picks, shovels, tents and blue-
Visiting stores and testing products is one of the critical elements of the analyst’s job
Max-Min of 1-2 variables -Business success through extreme maximization or minimization of 1 or 2 variables
In business we often find that the winning system goes almost ridiculously far in maximizing and or minimizin
The Network effect results from positive feedback, where success begets success and economies of scale undermin
The bottom line is that you're most likely to find the network effect in businesses based on sharing informatio
deal in rival (physical) goods... this is not exclusively the case, but it's a good rule of thumb.
If a product or service is widely and conveniently available, consumers are less likely to try the competition. Furthe
advantage of the easy availability.
Since there is only one cost leader, this is a powerful position for a company to hold.
As the product tends to commodity status, with price becoming the major issue for the buyer, the competitive p
in all shapes and sizes. Consider, for example, banks and the advantage of having the lowest cost of funds.
A good business model answers Peter Drucker’s age-old questions: Who is the customer? And what does the custo
manager must ask: How do we make money in this business? What is the underlying economic logic that explains h
Creating a business model is, then, a lot like writing a new story. At some level, all new stories are variations on old
experience. Similarly, all new business models are variations on the generic value chain underlying all businesses. B
the activities associated with making something: designing it, purchasing raw materials, manufacturing, and so on.
something: finding and reaching customers, transacting a sale, distributing the product or delivering the service. A n
product for an unmet need, as it did with the traveler’s check. Or it may turn on a process innovation, a better way
or service.
Keynes on stock picking as a beauty contest - “It’s not a case of choosing those [faces] that, to the best of one’s jud
opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anti
be. And there are some, I believe, who practice the fourth, fifth and higher degrees.”
“The difference between a good business and a bad business is that good businesses throw up one easy decision aft
“Frequently, you’ll look at a business having fabulous results. And the question is, “How long can this continue?” W
think about why the results are occurring now—and then to figure out what could cause those results to stop occur
“If you are in a business selling white paper for a dollar a pound, and your competitor sells it for a little less, I am pr
are selling me a glass of Johnnie Walker whisky for a dollar, and your competitor sells a glass of Uncle Joe’s whisky
Walker”
“There are two kinds of businesses: The first earns 12%, and you can take it out at the end of the year. The second
never any cash. It reminds me of the guy who looks at all of his equipment and says, ‘There’s all of my profit.’ We h
“If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century you’re
mediocre result you’re going to get compared to the people who do have the temperament, who can be more phil
Characteristics of good businesses
 High Barriers to Entry
 High Margins
 Good management
 Pricing Power
What are some barriers to entry?

 High switching costs
 High capital costs
 Brands
 Lower operating costs (airline with 1 low cost fleet, by operating in a certain way, locks you in)
 Tobacco with its addicted customers
I would define a good business where you can identify specifically a reason why it should be able to earn an excess
you can clearly see. Typically, good businesses where you are seeing that on a consistent basis, you rarely see them
Operators of multi-sided platforms must ask themselves several key questions: Can we attract sufficient numbers o
price sensitive? Can that side be enticed by a subsidized offer? Will the other side of the platform generate sufficien
What an investor needs is the ability to correctly evaluate selected businesses. Note that word “selected”: You don
only have to be able to evaluate companies within your circle of competence. The size of that circle is
not very important; knowing its boundaries, however, is vital.
If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that g
decent profit, even though the long-term performance of the business may be terrible. I call this the “cigar butt” ap
only one puff left in it may not offer much of a smoke, but the “bargain purchase” will make that puff all profit. Unle
businesses is foolish. Unless you are a liquidator, you may end up waiting a long time for that “puff” of profit. (so bu
Good business - Something that costs a penny, sells for a dollar and is habit forming.
Find a business any idiot could run because eventually one will.
If share of mind exists, the market will follow
You can learn a lot about the durability of the economics of a business by observing price behavior
It is important to know the one or two key factors in each business you own.
Experience, however, indicates that the best business returns are usually achieved by companies that are doing som
years ago. That is no argument for managerial complacency. Businesses always have opportunities to improve serv
obviously these opportunities should be seized. But a business that constantly encounters major change also encou
terrain that is forever shifting violently is ground on which it is difﬁ cult to build a fortress - like business franchise.
If it is not knowable, as you know there are all kinds of things that are important but not knowable, we forget abou
won't make any difference. We don't care. But there are enough things that are knowable and important that we fo
Economic analysis is basically marginal analysis. Marginal means additional. Economic theory is marginal analysis be
weighing additional costs against additional benefits. Nothing matters in decision making except marginal costs and
passenger may be $500, the marginal cost is merely the extra bag of peanuts and a drink. As long as the marginal p
is profitable.
The cost of any action is the value of the opportunity forgone by taking that action.Resources have other opportun
'crowd out' the next best application. Only actions have costs. One must do something to incur the cost. And costs
Reductionism is the cornerstone of discovery in the Newtonian world, the basis for much of science's breathtaking
scientist John Holland explains, 'The idea is that you could understand the world, all of nature, by examining smalle
would explain the whole.' In many systems reductionism works brilliantly.
But reductionism has its limits. In systems that rely on complex interactions of many components, the whole s
from the aggregation of the underlying components. Since the whole of the system emerges from the interac
simply by looking at the parts. Reductionism fails.
Every new era is marked and measured by key abundances and scarcities
In an information-rich world, the wealth of information means a dearth of something else: a scarcity of whate
consumes is rather obvious: it consumes the attention of its recipients. Hence a wealth of information creates
efficiently among the overabundance of information sources that might consume it.
The key thing in economics, whenever someone makes an assertion to you, is to always ask, "And then what?" Actu
should always ask, "And then what?"
The 80/20 Principle- It simply maintains that a minority of causes, inputs, or effort usually lead to a majority of the
80/20, a significant imbalance is often found in a myriad of situations.
What is strategy but resource allocation? When you strip away all the noise, that's what it comes down to. Strategy
cannot be everything to everybody, no matter what the size of your business or how deep its pockets.
Always ask where the competition might come from; and examine substitutable products. The customer group ofte
Do not focus on the product, rather keep focusing on the people who consume it (or don’t consume it) and their ch
always buys to accomplish something.
If you weren't already in this business would you enter it today? If not, what are you going to do about it?
Core Competence - As a company moves along a product (or process) path, knowledge is accumulated. Since most
company is able to further innovate, and therefore move quicker, along this chosen path. Companies that have dev
make it more difficult for a new entrant to compete.
Competitive advantage through people -There are several problems with seeking competitive advantage through in
is proprietary - the people who sell you robots or point-of-sale terminals or software to analyze production or servi
competitors. Your ability to obtain the benefits of, let alone get any advantage from, this technology - which is ofte
ability to implement it more rapidly and more effectively. This almost inevitably involves the skill and motivation of
Specialization - Adam's smith pin factory

These waves of technology, you can see them way before they happen, and you just have to choose wisely which o
waste a lot of energy, but if you choose wisely, it actually unfolds fairly slowly. It takes years. One of our biggest ins
business where we didn't own or control the primary technology, because you'll get your head handed to you. We
primary technology was going to be software. And we were pretty good at software.
The great lesson in microeconomics is to discriminate between when technology is going to help you (only newspap
Water shapes its course according to the nature of the ground over which it flows; the soldier works out his victory
What can the company do, that the other competitors will not be able to do?
The company must recognize that the world in which it is operating is changing at an ever-increasing rate.
High margins attract competition, and competition erodes profit opportunities. The best way to mute competition
potential entrant.
It is hard to introduce new, superior products in market arenas where established competitors already have a stron
marketing power, and reputation to be competitive, existing competitors can take strong defensive actions to regai
success if they combine technology disciplines, e.g., electronics and nucleonics, in a way that is
novel relative to existing competitive competencies.
Technology is just one avenue to industry leadership. Developing a consumer “franchise” is another. Service excelle
Whatever the case, a strong ability to defend established markets against new competitors is essential for a sound
The minute the business starts contracting, significant assets are not there. Under social norms and the new legal r
the minute the enterprise goes into reverse, some of the assets on the balance sheet aren't there anymore.
We realized that some company that was selling at 2 or 3 times book value could still be a hell of a bargain because
with an unusual managerial skill plainly present in some individual or other, or some system or other.
If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much d
huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive look
However, averaged out, betting on the quality of a business is better than betting on the quality of management. In
momentum, not the brilliance of the manager. But, very rarely, you find a manager who's so good that you're wise
In fact, any time anybody offers you anything with a big commission and a 200-page prospectus. don't buy it. Occas
However, over a lifetime, you'll be a long way ahead - and you will miss a lot of unhappy experiences that might oth
There are actually businesses. that you will find a few times in a lifetime, where any manager could raise the return
just by raising prices - and yet they haven't done it. So they have huge untapped pricing power that they're not usin
such a unique experience to take your grandchild to Disneyland. You're not doing it that often. And there are lots o
those prices a lot and the attendance stayed right up. So a lot of the great record of Eisner and Wells was utter brill
and Disneyworld and through video cassette sales of classic animated movies.
At Berkshire Hathaway, Warren and I raised the prices of See's Candy a little faster than others might have. And, of
pricing power. And it also had brilliant management. So a Goizueta and Keough could do much more than raise pric
The Washington Post - we bought it at about 20% of the value to a private owner. So we bought it on a Ben Graham
faced a situation where you had both the top hand in a game that was clearly going to end up with one winner and
was a real dream. They're very high class people - the Katharine Graham family. That's why it was a dream - an abso
And in Gillette's case, they keep surfing along new technology which is fairly simple by the standards of microchips.
hard for competitors to do. So they've been able to stay constantly near the edge of improvements in shaving. Ther
shaving market.
And GEICO had a perfectly magnificent business - submerged in a mess, but still working. Misled by success, GEICO
because they were making a lot of money, they knew everything. And they suffered huge losses. All they had to do
wonderful business that was lying there. And when you think about it, that's a very simple model. And it's repeated
Obviously there are industries where two brands can co-exist like Ford and Chevrolet, but there are others like new
other. That’s just the way it is. It’s hard to predict what will happen with two brands in a market. Sometimes they w
each other. I know of no way to predict whether they’ll compete moderately or to the death. If you could figure it o
The definition of a great company is one that will be great for 25 to 30 years.
Even a third-rate newspaper can generate adequate profits if it is the only paper in town. In addition to their franch
As Buffett points out, newspapers have low capital needs, so they can easily translate sales into profits. Newspaper
generating above-average returns on invested capital and reducing the harmful effects of inflation.
Buffett figures that a typical newspaper could double its price and still retain 90 percent of its readership.
Take the probability of loss times the amount of possible loss from the probability of gain times the amount of poss
Investment is an activity of forecasting the yield on assets over the life of the asset; speculation is the activity of for
If you're an investor, you're looking at what the asset—in our case, businesses—will do. If you're a speculator, you'
of the business.
Product differentiation and strong brand are not the same as a profitable franchise
Value of a brand is equal to the cost that it took to create the brand then branding by itself is not a source of value
Value is only created when incumbents have abilities that new comers cannot match
As long as newcomers can develop and distribute new products on an equal footing with incumbents all products e
Simplest form of competitive advantage is government franchise - cable franchise, broadcast television, telephone
Other competitive advantage is being a low cost producer- due to a patent, know-how, access to cheap resources,
There are situations where incumbents are at a cost disadvantage- where technology is changing rapidly
High switching cost can limit the arrival of new entrants
Economies of scale - high fixed cost and low variable cost e.g. shrink - wrapped software
Consumer franchise that are sustainable over decades must have a competitive advantage in recruiting new custom
The problem of declining profits in the face of increased price competition has challenged thousands of companies
other players. It is a truth universally acknowledged that all sensible people abhor commodity businesses. The stan
product or service from all the others.
Globalization of the luxury car market proved to be profitability's foe. Both in theory and in practice, product differ
franchise.
These three concepts-franchises, barriers to entry, and incumbent competitive advantages-amount to the same thi
of any value that exceeds the cost of reproducing a firm's assets.
In an open and competitive economy, there are only a limited number of ways in which customer behavior leads to
frequency, is probably the most powerful.
High switching costs are the most common source of customer captivity. If it costs money, time, and effort for a cus
have an advantage over entrants. For example, when a company changes software systems for payroll, benefits ma
important functions, the company has to spend not only on the software but also on extensive retraining of the sta
installation still goes up. The corporate graveyard is filled with firms that bet the business on introducing a new, im
In order for economies of scale to be worth something and have implications for the valuation of a particular comp
advantages that provide the company with a predominant share of the market in question. By themselves, econom
advantages.
Those that do not capitalize on their protected positions may be concealing substantial value in unused pricing pow
Rapid change in technology will often mean that, in the absence of economies of scale, cost structure advantages a
are long lasting, patents do expire, learning curves flatten, and the associated competitive advantages still disappea
range of technological environments-change not too fast and not too slow and even they have limited lives.
The HMO that has a 60 percent share of households in the New York metropolitan area will be able to benefit from
considerably larger HMOs with 30 percent shares of the Chicago, Miami, Dallas, San Diego
Structural competitive advantages come in only a few forms: exclusive governmental licenses, consumer (demand)
patents or other durable superiorities, and the combination of economies of scale thanks to a leading share in the r
The history of the luxury car market suggests that this kind of brand-mediated pricing power does not create a sign
ravages of competition. Even a marque as illustrious as Mercedes-Benz is not a major competitive advantage in this
The brand may be an essential element of the perceived value of the product. But by itself the brand does not cons
create a franchise. The aspects of consumer behavior that do create franchise value are those we have described in
to customer captivity.
Also, the value of brands is greatly enhanced by the presence of economies of scale. A sticker on a computer that s
but when accompanied by powerful economies of scale in chip design and production, even a weak brand becomes
Dealmaking beats working. Dealmaking is exciting and fun, and working is grubby. Running anything is primarily an
romantic, sexy. That’s why you have deals that make no sense.”
I don’t think anyone should buy a bank if they don’t have a feel for the bankers. Banking is a business that is a very
away.”
Great products rarely make a moat, though they can certainly juice short-term results.
The question to ask is not whether a firm has high market share, but rather how the firm achieved that share, whic
MOATS-A company can have intangible assets, like brands, patents, or regulatory licenses that allow it to sell produ
The products or services that a company sells may be hard for customers to give up, which creates customer switch
Some lucky companies benefit from network economics, which is a very powerful type of economic moat that can
Finally, some companies have cost advantages, stemming from process, location, scale, or access to a unique asset,
than competitors.
If a company can charge more for the same product than its peers just by selling it under a brand, that brand very li
The only time patents constitute a truly sustainable competitive advantage is when the firm has a demonstrated tra
well as a wide variety of patented products.
Regulations can limit competition—isn’t it great when the government does something nice for you? The best kind
rules, rather than one big rule that could be changed.
The higher the level of fixed costs relative to variable costs, the more consolidated an industry tends to be, because
Is this company providing a win-win for its entire ecosystem?
How could this business be affected by changes in other parts of the value chain that lie beyond the company’s con
the credit markets or the price of a particular commodity?
Moat Sources:
Intangible assets include brands, patents, or government licenses that explicitly keep competitors at bay.
Firms that have the ability to provide goods or services at lower cost have an advantage because they can und
products or services at the same prices as rivals, but achieve fatter profit margins. We consider economies of
Switching costs are those one-time inconveniences or expenses a customer incurs to change from one produc
change providers unless they are offered a large improvement in either price or performance, and even then,
switching in some industries.
The network effect occurs when the value of a particular good or service increases for both new and existing u
service, often creating a viscious circle that allows strong companies to become even stronger.
Efficient scale describes a dynamic in which a market of limited size is effectively served by one or just a few c
but potential competitors are discouraged from entering because doing so would result in insufficient returns
ts simply are hurt the least.
es of Costco
cisions time after time.”

nant position will be.
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FINANCE
In many businesses-particularly those that have high asset/profit ratios-inflation causes some or all of the reported
The ersatz portion-let's call these earnings "restricted"-cannot, if the business is to retain its economic positio
The first point to understand, is that not all earnings are created equal
For every dollar retained by the corporation, at least one dollar of market value will be created for owners.
This will happen only if the capital retained produces incremental earnings equal to, or above, those generally
Outstanding businesses by definition generate large amounts of excess cash.
Since the long-term corporate outlook changes only infrequently, dividend patterns should change no more often.
Major repurchases at prices well below per-share intrinsic business value immediately increase, in a highly s
purchase their own stock, they often find it easy to get $2 of present value for $1.
Earnings can be as pliable as putty when a charlatan heads the company reporting them. Eventually truth will surfa
The goal of each investor should be to create a portfolio (in effect, a "company") that will deliver him or her the hig
The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital
gimmickry, etc.) and not the achievement of consistent gains in earnings per share.
Managers and investors alike should view intangible assets from two perspectives:
(1) In analysis of operating results-that is, in evaluating the underlying economics of a business unit-amortizati
can be expected to earn on unleveraged net tangible assets, exclud- ing any charges against earnings for am
economic attractiveness of the operation. It is also the best guide to the current value of the operation's econ
(2) In evaluating the wisdom of business acquisitions, amortization charges should be ignored also. They sho
from the cost of the business.This means forever viewing purchased Goodwill at its full cost, before any amor
including the full intrinsic business value-not just the recorded accounting value-of all con- sideration given, ir
involved at the time of merger and irrespective of whether pooling treatment was allowed. For example, wha
of the Goodwill of See's and the News was considerably more than the $51.7 million entered on our books. Th
the Berkshire shares given up in the merger was less than their intrinsic business value, which is the value th
Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business durin
Intrinsic value is an estimate rather than a precise figure, and it is additionally an estimate that must be changed if
Does the company have a worthwhile profit margin?
What is the company doing to maintain or improve profit margins?
In the foreseeable future, will the growth of the company require sufficient equity financing so that the larger num
the existing stockholders’ benefit from this anticipated growth?
The promised benefits from these textile investments were illusory. Many of our competitors, both domestic and fo
expenditures and, once enough companies did so, their reduced costs became the baseline for reduced prices indu
capital investment decision appeared cost-effective and rational; viewed collectively, the decisions neutralized each
when each person watching a parade decides he can see a little better if he stands on tiptoes. After each round of i
the game and returns remained anemic
Is the business’s balance sheet strong or weak?

Are the accounting standards that management uses conservative or liberal?
Does the business generate revenues that are recurring or from one- off transactions?
To what degree does operating leverage impact the earnings of the business?
How does working capital impact the cash flows of the business?
Does the business have high or low capital- expenditure requirements?
Have the managers been buying or selling the stock?
Do the CEO and CFO issue guidance regarding earnings?
Once a business begins to set guidance, it may also adopt a short- term outlook at the expense of long- term g
Does the management team focus on cutting unnecessary costs?
Are the CEO and CFO disciplined in making capital allocation decisions?
Do the CEO and CFO buy back stock opportunistically?
EBITDA is bullshit earnings
“In financial terms it's easy to describe a high-quality business. They generate high returns on unlevered capital and
They produce free cash flow or have attractive enough reinvestment opportunities to invest cash flow at high retur
Steady cash flows comes from one reason or another, from indespensability of companys products - either from br
Best kind of business to own is one with high profit margins and high inventory turnover. Second-best kind of busin
or achieve enough inventory turnover to compensate for lower profit margins
Stock splits have three consequences: they increase transaction costs by promoting high share turnover; they attra
oriented views who unduly focus on stock market prices; and, as a result of both of those effects, they lead to price
value
Company that sells its stock at a price less than its value is stealing from its existing shareholders.
Sellers in stock acquisitions measure the purchase price by the market price of the buyer's stock, not by its intrinsic
equal to, say, half its intrinsic value, then a buyer who goes along with that measure gives twice as much in busines
rationalizing his or her actions by arguments about synergies or size, is elevating thrill or excessive optimism above
Acquisitions paid for in stock are too often (almost always) described as "buyer buys seller" or "buyer acquires selle
follow from saying "buyer sells part of itself to acquire seller," or something of the sort
Best value-enhancing transactions requires concentrating on opportunity costs, measured principally against the al
businesses through stock market purchases. Such concentration is alien to the manager obsessed with synergies an
It is common on Wall Street to value businesses using a calculation of cash flows equal to (a) operating earnings plu
charges. Buffett regards that calculation as incomplete. After taking (a) operating earnings and adding back (b) non-
subtract something else: (c) required reinvestment in the business. Buffett defines (c) as "the average amount of ca
etc., that the business requires to fully maintain its long-term competitive position and its unit volume." Buffett call
When (b) and (c) differ, cash flow analysis and owner earnings analysis differ too. For most businesses, (c) usually e
overstates economic reality.
If options aren't a form of compensation, what are they? If compensation isn't an expense, what is? And, if expense
where in the world should they go?"
Parochial positions on accounting can be economically disastrous, as the debate over accounting for retiree health
promised to pay for health care services to retired employees were not required by GAAP to record the associated
thus made it easy to make such financial commitments, and many businesses made far more generous commitmen
would have had they been required to report the obligation. One consequence was a wave of bankruptcies, as busi
maturing obligations.
Policies of the corporation in attracting shareholders to those of a restaurant attracting potential customers. A rest
fast foods, elegant dining, Oriental food, etc.-and eventually obtain an appropriate group of devotees. If the job we
the service, menu, and price level offered, would return consistently. But the restaurant could not change its chara
stable clientele. If the business vacillated between French cuisine and take-out chicken, the result would be a revol
Berkshire has access to two low-cost, non-perilous sources of leverage that allow us to safely own far more assets t
deferred taxes and "float," the funds of others that our insurance business holds because it receives premiums befo
Most investors think quality, as opposed to price, is the determinant of whether something’s risky. But high quality
be safe. It’s just a matter of the price paid for them.
An excellent investor may be one who— rather than reporting higher returns than others— achieves the same retu
less risk (or even achieves a slightly lower return with far less risk). Of course, when markets are stable or rising, we
entailed. That’s what’s behind Warren Buffett’s observation that other than when the tide goes out, we can’t tell w
naked.
Diversification is effective only if portfolio holdings can be counted on to respond differently to a given developmen
Risk control lies at the core of defensive investing. Rather than just trying to do the right thing, the defensive invest
wrong thing. Because ensuring the ability to survive under adverse circumstances is incompatible with maximizing
what balance to strike between the two. The defensive investor chooses to emphasize the former.
Hold any security indefinitely, so long as the prospective return on equity capital of the underlying business is satisf
is competent and honest, and the market does not overvalue the business.
To evaluate arbitrage situations you must answer four questions: (1) How likely is it that the promised event will ind
(2) How long will your money be tied up? (3) What chance is there that something still better will transpire-a comp
bid, for example? and (4) What will happen if the event does not take place because of anti-trust action, financing g
The other way we differ from some arbitrage operations is that we participate only in transactions that have been p
or try to guess takeover candidates. We just read the newspapers, think about a few of the big propositions, and go
The primary factors bearing upon this (equtiy investment) evaluation are:
1) The certainty with which the long-term economic characteristics of the business can be evaluated;
2) The certainty with which management can be evaluated, both as to its ability to realize the full potential of the b
3) The certainty with which management can be counted on to channel the reward from the business to the shareh
4) The purchase price of the business;
5) The levels of taxation and inflation that will be experienced and that will determine the degree by which an inves
his gross return.
The theoretician bred on beta has no mechanism for differentiating the risk inherent in, say, a single-product toy co
of another toy company whose sole product is Monopoly or Barbie
By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most in
"dumb" money acknowledges its limitations, it ceases to be dumb.
Growth is always a component in the calculation of value, constituting a variable whose importance can range from
be negative as well as positive.
Similarly, business growth, per se, tells us little about value. It's true that growth often has a positive impact on valu
one of spectacular proportions. But such an effect is far from certain. For example, investors have regularly poured
finance profitless (or worse) growth. For these investors, it would have been far better if Orville had failed to get off
industry has grown, the worse the disaster for owners.
Growth benefits investors only when the business in point can invest at incremental returns that are enticing-in oth
the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremen
Searching for operations that we believe are virtually certain to possess enormous competitive strength ten or twe
environment may offer the chance for huge wins, but it precludes the certainty we seek.
Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandabl
to be materially higher five, ten and twenty years from now.
A great investment opportunity occurs when a marvelous business encounters a one-time huge, but solvable, prob
American Express and GEICO.
The banking business is no favorite of ours. When assets are twenty times equity-a common ratio in this industry-m
assets can destroy a major portion of equity.
Huge debt, we were told, would cause operating managers to focus their efforts as never before, much as a dagger
be expected to make its driver proceed with intensified care. We'll acknowledge that such an attention-getter wou
certain consequence would be a deadly-and unnecessary-accident if the car hit even the tiniest pothole or sliver of
potholes; a plan that requires dodging them all is a plan for disaster.
We suspect three motivations-usually unspoken to be, singly or in combination, the important ones in most highpre
takeovers:
(1) Leaders, business or otherwise, seldom are deficient in animal spirits and often relish increased activity and cha
beats faster than when an acquisition is in prospect.
(2) Most organizations, business or otherwise, measure themselves, are measured by others, and compensate thei
by any other yardstick. (Ask a Fortune 500 manager where his corporation stands on that famous list and, invariabl
ranked by size of sales; he may well not even know where his corporation places on the list Fortune just as faithfull
profitability.)
(3) Many managements apparently were overexposed in impressionable childhood years to the story in which the i
toad's body by a kiss from a beautiful princess. Consequently, they are certain their managerial kiss will do wonder
During an inflationary period, companies with a core business characterized by extraordinary economics can use sm
business at very high rates of return. But, unless they are experiencing tremendous unit growth, outstanding busine
excess cash. If a company sinks most of this money in other businesses that earn low returns, the company's overal
appear excellent because of the extraordinary returns being earned by the portion of earnings incremental investe
While deals often fail in practice, they never fail in projections-if the CEO is visibly panting over a prospective acqui
the requisite projections to rationalize any price.
Current earnings per share (or even earnings per share of the next few years) are an important variable in most bus
far from all-powerful.
The sad fact is that most major acquisitions display an egregious imbalance: They are a bonanza for the shareholde
status of the acquirer's management; and they are a honey pot for the investment bankers and other professionals
wealth of the acquirer's shareholders, often to a substantial extent. That happens because the acquirer typically giv
Accounting numbers are the beginning, not the end, of business valuation.
A business may be well liked, even loved, by most of its customers but possess no economic goodwill. (AT&T, befor
but possessed not a dime of economic Goodwill.) And, regrettably, a business may be disliked by its customers but
Goodwill.
When we purchased See's in 1972, it will be recalled, it was earning about $2 million on $8 million of net tangible a
mundane business then had $2 million of earnings also, but needed $18 million in net tangible assets for normal op
assets, that mundane business would possess little or no economic Goodwill.
A business like that, therefore, might well have sold for the value of its net tangible assets, or for $18 million. In con
though it had no more in earnings and less than half as much in "honest-to-God" assets. Could less really have been
answer is "yes"-even if both businesses were expected to have flat unit volume- as long as you anticipated, as we d
To understand why, imagine the effect that a doubling of the price level would subsequently have on the two busin
earnings to $4 million to keep themselves even with inflation. This would seem to be no great trick: just sell the sam
assuming profit margins remain unchanged, profits also must double.
But, crucially, to bring that about, both businesses probably would have to double their nominal investment in net
economic requirement that inflation usually imposes on businesses, both good and bad. A doubling of dollar sales m
employed immediately in receivables and inventories. Dollars employed in fixed assets will respond more slowly to
this inflation-required investment will produce no improvement in rate of return. The motivation for this investmen
prosperity of the owner.
Remember, however, that See's had net tangible assets of only $8 million. So it would only have had to commit an
imposed by inflation. The mundane business, meanwhile, had a burden over twice as large-a need for $18 million o
the mundane business, now earning $4 million annually, might still be worth the value of its tangibleassets, or $36
gained only a dollar of nominal value for every new dollar invested. (This is the same dollar-for-dollar result they w
a savings account.)
See's, however, also earning $4 million, might be worth $50 million if valued (as it logically would be) on the same b
would have gained $25 million in nominal value while the owners were putting up only $8 million in additional capi
invested.
Asset-heavy businesses generally earn low rates of return, rates that often barely provide enough capital to fund th
with nothing left over for real growth, for distribution to owners, or for acquisition of new businesses.
In contrast, a disproportionate number of the great business fortunes built up during the inflationary years arose fr
of operations that combined intangibles of lasting value with relatively minor requirements for tangible assets. In s
nominal dollars, and these dollars have been largely available for the acquisition of additional businesses. This phen
communications business. That business has required little in the way of tangible investment-yet its franchises have
that keeps giving.
Assume a company with $20 per share of net worth, all tangible assets. Further assume the company has internally
franchise, or that it was fortunate enough to obtain some important television stations by original FCC grant. There
$5 per share, or 25%. With such economics, it might sell for $100 per share or more, and it might well also bring tha
business.
Assume an investor buys the stock at $100 per share, paying in effect $80 per share for Goodwill Just as would a co
Should the investor impute a $2 per share amortization charge annually ($80 divided by 40 years) to calculate "true
"true" earnings of $3 per share cause him to rethink his purchase price?
Most managers probably will acknowledge that they need to spend something more than (b) on their businesses ov
terms of both unit volume and competitive position. When this imperative exists-that is, when (c) exceeds (b) GAAP
this overstatement is substantial. The oil industry has in recent years provided a conspicuous example of this pheno
only (b) each year, they would have guaranteed their shrinkage in real terms.
Absurdity of the "cash flow" numbers that are often set forth in Wall Street reports. These numbers routinely includ
brochures of investment bankers also feature deceptive presentations of this kind. These imply that the business b
the Pyramids-forever state-of-theart, never needing to be replaced, improved or refurbished. Indeed, if all U.S. corp
sale through our leading investment bankers-and if the sales brochures describing them were to be believed-gover
equipment spending would have to be slashed by 90%.
"Cash Flow," true, may serve as a shorthand of some utility in descriptions of certain real estate businesses or othe
that make huge initial outlays and only tiny outlays thereafter. A company whose only holding is a bridge or an extr
gas field would be an example. But "cash flow" is meaningless in such businesses as manufacturing, retailing, extrac
(c) is always significant. To be sure, businesses of this kind may in a given year be able to defer capital spending. Bu
the investment-or the business decays.
Why, then, are "cash flow" numbers so popular today? In answer, we confess our cynicism: we believe these numb
used by marketers of businesses and securities in attempt to justify the unjustifiable (and thereby to sell what shou
unsalable). When (a)-that is, GAAP earnings-looks by itself inadequate to service debt of a junk bond or justify a foo
salesmen to focus on (a) + (b). But you shouldn't add (b) without subtracting (c): though dentists correctly claim tha
same is not true for (c). The company or investor believing that the debt-servicing ability or the equity valuation or
and (b) while ignoring (c) is headed for certain trouble.
The greater the number of economically diverse business operations lumped together in conventional financial stat
In the case of unregulated businesses blessed with strong franchises: the corporation and its shareholders are then
In the price-competitive industry, whose companies typically operate with very weak business franchises. In such in
profits in a delayed and irregular, but generally effective, manner. The marketplace, in effect, performs much the sa
competitive industry as the Public Utilities Commission does in dealing with electric utilities. In these industries, the
more than profits.
Return-on-capital metrics measure the effectiveness of a company’s capital allocation decisions and are also arguab
positioning and competitive advantages. Theoretically, returns on capital should equal the opportunity cost of capit
economic profit normally draws competition, and competitive pressure gradually erodes profitability to erase econ
markets, companies earn no economic profit. To achieve sustained high returns on capital requires possessing feat
namely, competitive advantages.
Three elements drive corporate cash return on investment: asset turns, profit margins and cash conversion. Asset t
generates sales from additional assets, which can vary greatly depending on the asset intensity of the industry itsel
incremental sales; and cash conversion reflects a company’s working capital intensity and the conservatism of its ac
The simplest and most commonly used tool for measuring returns is return on equity: net income as a percentage o
proxy, the figure is crude for two reasons. Most obviously, the return part of the equation uses accounting measure
considerable discretion over the treatment of important measures such as depreciation and provisioning. The calcu
the value of shareholders’ equity, such as write-downs and debt levels.
Measures such as return on invested capital (measured as net after-tax operating profit divided by invested capital
is a metric zeroing in on cash returns on cash capital invested (CROCCI);this is measured as after-tax cash earnings d
accounting conventions such as amortization of goodwill. CROCCI measures the post-tax cash return on all capital a
Asset-light industries are attractive since they require less capital to be deployed in order to generate sales growth.
such as Domino’s Pizza, where growth is funded by franchisees rather than by the company. Other instances includ
Systèmes, a leading European developer of design software.
Although gross margin is a partial function of a company’s industry and high gross margins can reflect low asset inte
relative to industry peers tends to indicate durable competitive advantage. Businesses with high operating margins
ones. A company that consistently achieves both high gross and high operating margins indicates a strong competi
Opportunities for growth maximize the benefits derived from high returns on capital. Such opportunities can arise f
or through a firm grabbing share from rivals in existing markets or expanding geographically. The very best compan
through ingenuity in the design of products, pricing, and product mix.
A more common source of growth comes through price/mix optimization. For example, a boxed chocolate maker m
premium package and increase its price by more than its additional cost. As total revenues rise, the excess increase
Five ways a company can increase earnings:

1) Reduce costs
2) Raise prices - You can raise the price with an exclusive franchise.
3) Expand into new markets
4) Sell more of its product in old markets
5) Revitalize, close or otherwise dispose of a losing operation
Avoid "diworseifications" - "Instead of buying back shares or raising dividends, profitable companies often prefer to
dedicated diworseifier seeking out merchandise that is (1) overpriced and (2) completely beyond his or her realm o
maximized."
The company that sells 20 to 25 percent of its wares to a single customer is in a precarious situation.... short of can
leverage in extracting price cuts and other concessions that will reduce the supplier's profits. it's rare that a great in
arrangement.
Percent of Sales' tells you how much percentage a specific product is contributing to the overall revenue of the com
The cash position also tells you the floor to which the stock price could fall. When it comes to Cash Position, it is als
proposing to do with the cash that it has got.
If the business dividends out all free cash flow, a long-term shareholder will earn a return equal to the free cash flo
The return on capital earned by the business is irrelevant when the payout ratio is 100 percent. As the payout ratio
becomes increasingly important.
I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it so that you had 20 punc
got to make in a lifetime. And once you'd punched through the card, you couldn't make any more investments at a
There is a huge amount of difference between business that requires a large amount of capital to grow and the bus
The CEO who misleads others in public would mislead himself in private
“[Projections] are put together by people who have an interest in a particular outcome, have a subconscious bias, a
Forecasts tell you a gread deal about the forecaster, they never tell you anything about the future
Many corporate compensation plans reward managers handsomely for earnings increases produced solely, or in la
withheld from owners. For example, ten-year, fixed-price stock options are granted routinely, often by companies w
earnings.
It’s fine for a CEO to have his own internal goals and, in our view, it’s even appropriate for the CEO to publicly expre
expectations are accompanied by sensible caveats. But for a major corporation to predict that its per-share earning
annually is to court trouble.
When things go bad, all kinds of things correlate that you wouldn’t think of. Buffett said this is deadly. If you are no
unrecognized concentration of risk
Why is the stock price depressed?
Are they selling below book value?
Is goodwill in book value?
What has been the high-low over past 10 years?
Have they any cash flow?
Have they any net income?
How have they done over the past 10 years?
What is their debt level?
What kind of industry are they in?
What are their profit margins?
How are their competitors doing?
Has the company done poorly with respect to their competitors?
How much is the downside and upside potential?
How much stocks do the insiders own?
What is the company product? Can the company continue selling it for years? Prefer product over service
Be aware of the level of stock market- are yields low and P-E ratios too high, are too many IPOs , are people overop
Does the company have a worthwhile profit margin?
Companies with less profit margin more rapidly increase their earnings in abnormally good years but they do
earnings will decline more rapidly when the business tide turns
Sometimes companies deliberately speed up growth by spending all of their earnings on even more research
What is the company doing to maintain or improve profit margins?
Wages and salaries go up every year, which in turn affect raw material and supplies cost, as a result profit mar
Some companies maintain profit margins by rasising prices but that is temporary
Some companies maintain margin by capital improvement or product engineering department - to reduce cos
The intrinsic value of a firm is either the reproduction costs of the assets, which should equal the EPV, or those asse
that underlie its franchise
The only growth that creates value is growth in markets where company enjoys a competitive advantage
Three slices of value - asset value, Earning power value, value of growth
The more common condition that explains an EPV that is greater than asset value is when a firm enjoys substantial
The value of franchise lies not only in its current earning power but also in the possibilities for profitable growth. Th
instrinsic value is growth within the franchise growth that because of the competitive advantage of the firm can ea
suport it
New entrants will appear till the EPV becomes equal to the asset value
Intrinsic value estimates based on earnings are inherently less reliable than estimates based on assets.
When we consider economically viable industries, there are three possible situations. In the first, the firm's EPV ma
of its assets. In this case, management is not using the assets to produce the level of earnings that it should. The cu
doing. In the second, the EPV and the asset value are more or less equal. This is the situation we would expect to se
advantages. If a careful analysis of the structure of costs and customer demand supports this conclusion, then the a
and our confidence in both is increased. In the third situation, if the EPV, properly calculated, is significantly higher
we are looking at an industry setting in which there must be strong barriers to entry. Firms within the barriers will e
to the humbling experience of seeing new entrants join the party with no handicap for arriving late. For the EPV to
sustainable at the current level for the indefinite future.
The defining character of a franchise is that it enables a firm to earn more than it needs to pay for the investments
asset value; the difference between the two, as we said, is the value of the franchise. Therefore, the intrinsic value
assets, which should equal the EPV, or those assets plus the competitive advantages of the firm that underlie its fra
Situations in which growth has value arise when the firm's EPV substantially and sustainably exceeds its asset value
For a manufacturing firm, the more commodity-like the inventory, the less the discount necessary to sell it. It is tho
down, not the cotton yarn. If, on the other hand, the inventory consists of cartons of last year's unsalable toys, then
away. We estimate in this case that we can realize 50 percent on the inventory; if the inventory is highly specialized
substantially lower.
"Is goodwill worth anything?" - it all depends on the source of the goodwill, and for that we need information and i
Let's say we estimate the asset value of a company, after deducting spontaneous liabilities, at $100 million, and it h
the equity at $20 million. But if we are off by 10 percent, and the true value is $90 million, the value of the equity s
margin of safety may be eliminated and then some. Because leverage can be the foe of the margin of safety, many
have high levels of debt.
It is useful to think of liabilities as falling into three categories.
First are those liabilities that arise intrinsically from the normal conduct of the business: accounts payable to s
due to employees, accrued taxes due to governments, and other accrued expenses. Most of these are current
The second class of liabilities consists of those obligations that arise from past circumstances that are not perti
tax liabilities or liabilities incurred because of adverse legal judgments (e.g., our company broke the law and o
not relevant for the newcomer. The tax law may have changed, or this firm's experience may effectively deter
mistakes. Liabilities like these do not reduce the investment a potential entrant will have to make, but becaus
be paid, they do need to be subtracted from the asset value to see what this firm is worth to investors.
The third class of liabilities is the outstanding formal debt of the company. The appropriate treatment of the d
the reproduction cost of the assets and then subtract the first two categories of liabilities (spontaneous and w
with the asset value of the whole enterprise to which investors have claims. This value will be divided betwee
the equity. If we are shareholders or are looking to make an equity investment, we need to subtract the value
value of the debt, if available; if not, the book value is generally an adequate alternative
Finding the reproduction cost of a firm's assets and liabilities takes more work, more knowledge, and more everyth
figures.
Whenever an investment banker starts talking about EBDIT—or whenever someone creates a capital structure that
accrued, to be comfortably met out of current cash flow net of ample capital expenditures— zip up your wallet
The lower the government bond yield, the more valuable stocks will be, all else equal.
If your actions are sensible, you are certain to get good results; in most such cases, leverage just moves things alon
Our endorsement of repurchases is limited to those dictated by price/value relationships and does not extend to th
find odious and repugnant. In these transactions, two parties achieve their personal ends by exploitation of an inno
players are: (1) the “shareholder” extortionist who, even before the ink on his stock certificate dries, delivers his “y
managers; (2) the corporate insiders who quickly seek peace at any price—as long as the price is paid by someone e
is used by (2) to make (1) go away. As the dust settles, the mugging, transient shareholder gives his speech on “free
its speech on “the best interests of the company,” and the innocent shareholder standing by mutely funds the payo
Though historical volatility is a useful—but far from foolproof—concept in valuing short-term options, its utility dim
lengthens. In my opinion, the valuations that the Black-Scholes formula now place on our long-term put options ov
will diminish as the contracts approach maturity.
The efficient market hypothesis does not live or die by investor rationality. In many scenarios where some investors
predicted to be efficient. In one commonly discussed case, the irrational investors in the market trade randomly. W
and when their trading strategies are uncorrelated, their trades are likely to cancel each other out. In such a marke
Where you have complexity, by nature you can have fraud and mistakes. . . . This will always be true of financial com
you want accurate numbers from financial companies, you’re in the wrong world
Use price/cash flow as an indicator along with P/E and P/B
Sell a stock when its PE ratio apporaches that of an overall market, regardless of how favorable prospects may appe
2.5 to 3 years is an adequate waiting period, if after that time the stock still dissapoints, sell it
Do not sell a stock which achieves a high PE ratio solely because of decline of earnings, either due to one time char
if we assume all earnings are paid out and we ignore the impact of tax, a business returning 20 percent on invested
four times as valuable as another earning 5 percent on invested capital in perpetuity—a “bad” business. If long-term
then the good business earning 20 percent on equity is worth no more than twice (20 percent ÷ 10 percent = 2×) its
earning 5 percent on invested capital is worth no more than half its invested capital (5 percent ÷ 10 percent = 0.5×)
With the long bond earning 10 percent, each dollar of earnings reinvested in the good business earning a 20 p
up to 200 cents on the dollar in business value (20 percent ÷ 10 percent), which is a very good return. Contras
business returning 5 percent on capital. Each dollar of earnings reinvested in that business will become 50 cen
10 percent), thereby chewing up half the value of any dollar invested in it. The owner of the good business ea
business to reinvest, and grow because that growth is profitable. The owner of the bad business earning 5 per
paid out because the “growth” destroys value.
If the yield on the government bond falls to 5 percent, the value of the bad business rises to no more than its
and the value of the good business rises to no more than four times its invested capital (20 percent ÷ 5 percen
government bond rises to say 20 percent, the value of the bad business falls to no more than one-quarter its i
and the value of the good business falls to no more than one times its invested capital (20 percent ÷ 20 perce
Skilled managers maximize a business’s intrinsic value by maximizing its return on invested capital, which means m
denominator (the invested capital) over the course of the business cycle. In practice, this means paying out as much
invested capital, to minimize the invested capital employed in the business. This reduces the size of the invested ca
return on invested capital. It also means avoiding investments that might incrementally increase earnings, but offer
threshold rate of return set by the market. Most managers, through their employment contracts, bonuses, and opti
maximize the return on invested capital, but to maximize only the growth in the numerator—the earnings.
y can change hands.
decade or so from now.
ure cash flows are revised.

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HR
Does the company have outstanding labor and personnel relations?
Relative labor turnover with respect to other companies
Realtive waiting list of candidates waiting to join a company
Above average profits while paying above average wages
Profit sharing and pension plans can play a role in improving relations
Good communication to and from from all levels of employees
Does the company have outstanding executive relations?
Does the company have depth to its management?
“In any big business, you don’t worry whether someone is doing something wrong, you worry about whether it’s bi
“ ‘One solution fits all’ is not the way to go. . . . The right culture for the Mayo Clinic is different from the right cultu
“The highest form that civilization can reach is a seamless web of deserved trust—not much procedure, just totally
another. . . . In your own life what you want is a seamless web of deserved trust.”
There must always be a conscious and continuous effort, based on fact, not propaganda, to have employees at eve
white-collar worker to the highest levels of management, feel that their company is a good place to work
o a lot to mitigate bad behavior, but you simply can’t prevent it altogether."
an’t run all these places with a cookie-cutter solution.”
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OPERATIONS
How good are the company’s cost analysis and accounting controls?
Institutional Imperative: (1) As if governed by Newton's First Law of Motion, an institution will resist any change in
fill available time, corporate projects or acquisitions will materialize to soak up available funds; (3) Any business cra
quickly supported by detailed rate-of-return and strategic studies prepared by his troops; and (4) The behavior of p
acquiring, setting executive compensation or whatever, will be mindlessly imitated.
Braun's Five W's: Who, what, where, when and why.

If you tell people why, they'll be much more likely to comply.
What are the operating metrics of the business that you need to monitor?
One mistake many companies make is applying the same performance metrics to all their businesses and stra
a desire to please the financial markets… but these measures tend to be more appropriate for later-stage, ma
picture of newer, more experimental ventures.
In such businesses, milestone measures such as hiring a key executive, winning early customers, and meeting
Second, financial measures are often lagging indicators of the market’s feedback. Other, more operational me
time, sales per square foot, employee turnover, and rework time, when added to financial data, may provide
Does the management team improve its operations day- to- day or does it use a strategic plan to conduct its busine
Day to day improvement is better than a straightjacket strategic plan
Is the business managed in a centralized or decentralized way?
Centralized is typically more bureaucratic
“You’ve got a complex system and it spews out a lot of wonderful numbers that enable you to measure some facto
important, [yet] there’s no precise numbering you can put to these factors.”
We delegate to the point of abdication
Management changes, like marital changes are expensive, time consuming and chancy
Many corporate managers are told to submit budgets and quarterly estimates. This leads to a short-term focus and
does not want to let the boss down may fudge the numbers
He suggests the “newspaper” standard: behave as if your actions will be on the front page of the local newspaper.
A firm with a strong financial team has several important advantages:

a. Good cost information enables management to direct its energies toward those products with the highest poten
b. The cost system should pinpoint where production, marketing, and research costs are inefficient even in sub-par
c. Capital conservation through tight control of fixed and working capital investments.
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LEGAL AND GOVERNANCE
Many annual meetings are a waste of time, both for shareholders and for management. Sometimes that is true bec
matters of business substance. More often a non-productive session is the fault of shareholder participants who ar
stage than they are about the affairs of the corporation. What should be a forum for business discussion becomes a
advocacy of issues.
Relations between the Board and the CEO are expected to be congenial. At board meetings, criticism of the CEO's p
equivalent of belching. No such inhibitions restrain the office manager from critically evaluating the substandard ty
First, stock options are inevitably tied to the overall performance of a corporation. Logically, therefore, they should
responsibility. Managers with limited areas of responsibility should have incentives that payoff in relation to results
Second, options should be structured carefully. Absent special factors, they should have built into them a retained-
cost factor. Equally important, they should be priced realistically.
The combination of a ten-year option, a low dividend payout, and compound interest can provide lush gains to a m
in his job.
Investment risk is largely invisible before the fact— except perhaps to people with unusual insight— and even after
Having first-rate people on the team is more important than designing hierarchies and clarifying who reports to wh
Director power is weakest in the case where there is a controlling shareholder who is also the manager. When disa
management, there is little a director can do other than to object and, in serious circumstances, resign. Director po
there is a controlling shareholder who does not participate in management. The directors can take matters directly
disagreement arises.
The most common situation, however, is a corporation without a controlling shareholder. This is where manageme
most acute, Buffett says. It would be helpful if directors could supply necessary discipline, but board congeniality us
Many corporations pay their managers stock options whose value increases simply by retention of earnings, rather
Buffett explains, however, simply by retaining and reinvesting earnings, managers can report annual earnings incre
improve real returns on capital. Stock options thus often rob shareholders of wealth and allocate the booty to exec
are often irrevocable, unconditional, and benefit managers without regard to individual performance
Executive performance should be measured by profitability, after profits are reduced by a charge for the capital em
retained by it. If stock options are used, they should be related to individual performance, rather than corporate pe
Better yet, as at Berkshire, stock options should simply not be part of an executive's compensation. After all, excepti
on the performance of their own business can simply buy stock if they want to; if they do, they "truly walk in the sh
Earnings are often retained for non-owner reasons, such as expanding the corporate empire or furnishing operation
Buffett’s view is that the most important job of the board is to pick the right CEO. The second most important job is
often happens in acquisitions.
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SALES
BD is the finanl frontier, it involves seeing all the functions of both the parties
Does the company have an above average sales organization?
Sales is all about relationship - you like us and we like you - rest just follows - half of the time it boils down do -I don
Social exchange based on affirmation - thinking is based on negation - don’t make people think - don’t argue w
When dealing with people, let us remember we are not dealing with creatures of logic. We are dealing with cr
creatures bristling with prejudices and motivated by pride and vanity.
Smile - trade a smile with someone who is blue now (emotions are contagious) - when you smile the whole w
Remember names - name is the sweetest sound to a person - associate an image with a name
Make the conversation about the other person - listen - let the other person do a great deal of talking- talk ab
Interact - Interact - Interact - do not miss any chance of having a conversation
The only way on earth to influence other people is to talk about what they want and show them how to get it
Cognitive empathy - emotional empathy - empathic concern (seed of compassion)
Sales or BD funnel - take the client through different stages - AIDA - Cold, warm, hot, sold
Prospecting
Building rapport
Identifying needs
Presenting
Answering objections
Closing the sale
Getting resales and referrals
First, arouse in the other person an eager want.

Appeal to interest, not to reason - talk in terms of other people's interest
Logic makes people think, but it is emotion that makes then act
The fear of loss is often greater than the desire for gain - two main reason people buy or don’t buy are desire for
Connectors ( See every person as an opportunity), Maven and Salesman (exude enthusiasm about your product) - p
The most effective sales call is 25% talking / questioning and 75% listening
The prospect
People believeis more
persuaded more
of what theybysee
thethan
depth of your
what they conviction
hear. – usethan he is by the
testimonials height
- social of your logic.
proof
You are not selling what it is…you sell what it does. Prospects do not buy products. Prospects buy products of the p
Start your presentation with the strongest benefit and end with the second strongest benefit
Always ask for the order - AAFTO
Have an absolute and total belief that what you're selling is worth more than the price you ask for it. Your belief in
Mentally prepare yourself. Review your product knowledge and selling skills before every call. Try to write down yo
presentation, and you'll discover that you are using too many words, that you drift away from the point, or that you
specific enough. Writing will remind you of something you've forgotten and help you generate better selling ideas.
Use emotion and logic in your presentation. Logic makes people think; emotion makes them act.
You need to balance these keys. If you use all logic, you end up with the best-educated prospect in town. If you use
When you get a referral contact them as soon as possible.
People buy because they either need or want something. If we can give someone a reason for buying (satisfying ne
Never lead with a product, lead with need
Don’t waste people time telling them what a product is, tell them what it can do and why it will do it for them
Needs Solution:
Everything you talk about with prospects should translate to customer benefits.
Investing timebenefits
Personalize in the right
for place - prospecting
the prospect. Paint -the
likepicture
OP in RKforhall
them - multiple
so they power
can seecenters,
it. your connects , influence
Clearly articulate
Behavioral biases: the features, functions and benefits of your product.
Bias from mere association - automatically connecting a stimulus with pain or pleasure; including liking or disliking
something bad or good. Includes seeing situations as identical because they seem similar. Also bias from Persian M
Underestimating the power of rewards and punishment - people repeat actions that result in rewards and avoid ac
Underestimating bias from own self-interest and incentives
Self-serving bias - overly positive view of our abilities and future. Includes over-optimism.
Self-deception and denial-
Bias from consistency distortion
tendency of consistent
- being reality to reduce
with ourpain or increase
prior pleasure.
commitments andIncludes
ideas evenwishful
whenthinking.
acting against
face of disconfirming evidence. Includes confirmation bias - looking for evidence that confirms
Bias from deprival syndrome - strongly reacting (including desiring and valuing more) when something we like our actions and and
belie
threatens to be) taken away or "lost." Includes desiring and valuing more what we can't have or what is (or threate
Status quo bias and do-nothing syndrome - keeping things the way they are. Includes minimizing effort and a prefe
Bias from envy
Distortion and jealousy.
by contrast comparison - judging and perceiving the absolute magnitude of something not by itself but b
something else presented closely in time or space or to some earlier adaptation level. Also underestimating the con
Bias from anchoring - over-weighing certain initial information as a reference point for future decisions.
Over-influence by vivid or the most recent information.
Bias
Bias from
from reciprocation
over-influencetendency
by liking -tendency
repaying-inbelieving,
kind what othersand
trusting haveagreeing
done forwith
or to us likewe
people favors,
knowconcessions, info
and like. Include
liking and social acceptance and for avoiding social disapproval. Also bias from disliking - our tendency to avoid and
Bias from over-influence by social proof - imitating the behavior of many others or similar others. Includes crowd fo
Bias from over-influence by authority - trusting and obeying a perceived authority or expert.
Reason-respecting - complying with requests merely because we've been given a reason. Includes underestimating
like this guy
h them - don’t burst their bubbles - criticism is futile
atures of emotion,
d smiles at you (mirror neurons)
t other people's interest
appeal to interest and not to reason
in and fear of loss

y role of all three
ducts — known as benefits.
ur product should be so great that you ought to be using it
l emotion, you make the sale, but tomorrow you'll have the buyer's remorse and a canceled order.
s) and an excuse for buying (satisfying wants), the chances are dramatically improved that they will do so.
and decision make. No such thing as a groupthink - always one decision maker. “A prospect is an individual or a group capable
mething associated with

senger Syndrome - not wanting to be the carrier of bad new
ns that they are punished for
ur best interest or in the

and
ve (orignoring or distorting
almost have) is (or disconfirming evidence.
to be) less available
nce for default options.
ed only on its difference to
equences over time of gradual changes
mation andover-desire
bias from attitudes for
sagree with people we don't like.
e power in giving people reasons

hey will do so.
is an individual or a group capable of making the decision on the product or service the salesperson is selling. ”
n the product or service the salesperson is selling. ”
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MARKETING
Brand names are not guarantees. But they do reduce the range of uncertainty. Since brand names are a substitute
depends on how much knowledge you already have about the particular product or service. Someone who is very k
to get a bargain on an off-brand camera or lens, or even a second-hand camera or lens. But the same person might
of new stereo equipment, if his knowledge in that field falls far short of his expertise in photography.
Owning a piece of consumers mind - which means you don’t have to change the product very often
80% of advertising is about creating pavlovian associations
The bottom line is that brands can create durable competitive advantages, but the popularity of the brand matters
consumers' behavior. If consumers will pay more for a product - or purchase it with regularity - solely because of th
But there are plenty of wellknown brands attached to products and companies that struggle to earn positive econo
returns.
Popular brands aren't always profitable brands. If a brand doesn't entice consumers to pay more, it may not create
Product brand continumm - is it a product or a brand
Cost of creating value < price < perceived value
A firm must have a strong enough customer orientation to recognize changes in customer needs and interests and
appropriate manner. This capability should lead to generating a flow of new products that more than offset lines m
Some companies do indeed charge higher prices than their competitors, but that merely reflects a higher cost of pr
confer pricing power that at least offsets any difference in costs.
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INDUSTRY ANALYSIS
We are not fit to lead an army on the march unless we are familiar with the face of the country—its mountains and
So we think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the prim
the moat widened every year.
That doesn't necessarily mean the profit will be more this year than it was last year because it won't be sometimes
very well.
The company with the moat is worth more today because it will generate economic profits for a longer stretch of ti
buying a stream of cash flows that is protected from competition for many years. It's like paying more for a car that
out in a few years.
Strategy explains how an organization, faced with competition, will achieve superior performance
Essence of strategy is choosing what not to do. One upmanship is not strategy. Strategic competition means choosi
unlike warfare in that one company’s success does not require its rivals to fail. It is unlike competition in sports bec
analogy than war or sports might be the performing arts. There can be many good singers or actors—each outstand
audience. The more good performers there are, the more audiences grow and the arts flourish. This kind of value c
Competing to be the best feeds on imitation. Competing to be unique thrives on innovation.
If the rivals all pursue the one best way to compete, they will find themselves on a collision course - competitive co
suffered from this sort of competition for decades, in many categories of consumer electronics, and in personal com
When all else fails and pressure on prices has destroyed an industry’s profitability, often the remedy is to limi
other up, thus reducing the number of rivals and allowing one or a few companies to dominate the market.
When all rivals compete on the same dimension, no one gains a competitive advantage. Head-to-head competition
serve them.
Customers may benefit from lower prices as rivals imitate and match each other’s offerings, but they may also
a standard offering, the “average” customer may fare well. But remember that averages are made up of some
individuals in both groups who will not be well served by the average.
The needs of some customers may be overserved by what the industry offers. In plain English, you will pay mo
about my word processing software. It is also true of most of the appliances in my kitchen. These products ha
and I am both a professional writer and an accomplished cook. As they have become more complex, they hav
customers may be underserved. Think about the last flight you took. It probably met the basic need of getting
Are you eager to fly again?
Competition to be best versus competition to be unique (operational effectiveness versus competitive advantage).
“the best.” The best hotel for one customer is not the best for another. The best sales encounter for one customer
best way to promote environmental sustainability.
In war, there can be only one winner. Victory requires that the enemy be crippled or destroyed. In business, howev
focuses more on meeting customer needs than on demolishing rivals. Just look around. Because there are so many
Industry structure determines profitability - and is sticky (but dynamic) - always analyzed from the perspective of co
Competitive forces - Bargaining power of suppliers, customers, threat of substitutes, new entrants, competition be
Forces range from intense in industries like tires, paper, and steel—where no firm earns spectacular returns—
cosmetics, and toiletries—where high returns are quite common.
In the ocean-going tanker industry the key force is probably the buyers (the major oil companies), whereas in
tough competitors. In the steel industry the key forces are foreign competitors and substitute materials.
Customers, suppliers, substitute products, new entrants are all "competitors" of a company - extended rivalry
Strategy can be defined as building defences against competitive forces or finding a position within an industry whe
Extreme case of competitive intensity is economists's perfectly competitive industry - where entry is easy, existing
rivalry is unbridled because all products and services are alike
Strategy choices aim to shift relative price or relative cost in a company’s favor. Ultimately, of course, it’s the sprea
The goal of competitive strategy is to earn superior results on resources deployed and can be best measured by ret
Value proposition answers three questions - what customers - what needs - what relative prices
Only a value proposition that requires a tailored value chain can be a basis of a robust strategy
Trade offs are choices that make strategy susutainable because they are not easy to match or neutralize
Fit means that value of one activity is affected by the way other activities are perfomed
Good strategies depend on the connection of many things, on making independent choices - fit
Balance of forces is partly due to structural factors are partly within a firms control
One popular management book, Blue Ocean Strategy, uses the metaphor of red oceans versus blue to distinguish b
its authors say, competition is irrelevant.Competition properly understood, is never irrelevant. Most industries exis
The real point of competition is not to beat your rivals. It’s to earn profits
Industry structure determines profitability—not, as many people think, whether the industry is high growth or low,
Structure trumps these other, more intuitive, categories.
The five forces framework explains the industry’s average prices and costs, and therefore the average industry profi
more pressure it will put on prices or costs or both, and therefore the less attractive the industry will be to its incum
Industries can, and often do, create a lot of value for their customers or suppliers while the companies themselves
Managers often mistakenly assume that a high-growth industry will be an attractive one. But growth is no guarante
put suppliers in the driver’s seat, or, combined with low entry barriers, growth might attract new rivals. Growth alo
substitutes. The untested assumption that a fast-growing industry is a “good” industry, Porter warns, often leads to
Typical steps in industry structure analysis:

1. Define the relevant industry by both its product scope and geographic scope.
Product scope. Is motor oil used in cars part of the same industry as motor oil used in trucks and st
marketed through consumer advertising, sold to fragmented customers through powerful channel
packaging. Truck and power generation lubricants face a different industry structure
Although some elements are the same, buyers are radically different in the United States and Mex
need a separate strategy for each market.
2. Identify the players constituting each of the five forces and, where appropriate, segment them into groups.
3. Assess the underlying drivers of each force
4. Step back and assess the overall industry structure.
5. Analyze recent and likely future changes for each force
6. How can you position yourself in relation to the five forces?
7. Ask key questions:
Why is current industry profitability what it is? What’s propping it up?
What’s changing? How is profitability likely to shift?
What limiting factors must be overcome to capture more of the value you create?
Good strategies are like shelters in a storm. Five forces analysis will give you a weather forecast.
Bargaining power of suppliers (affects cost)

If you have powerful suppliers, they will use their negotiating leverage to charge higher prices or to insist on more f
because suppliers will capture more of the value for themselves. Makers of personal computers (PCs) have long str
case, the Intel Inside campaign effectively branded what might have otherwise become a commodity component
A supplier group is powerful if:
More concentrated than the industry
There are no substitute products
Industry is not an important customer of supplier group
Suppliers product is an important input to buyers business
Suppliers product is differentiated or it has built up switching cost
Credible threat of forward integration
Employees and Labour are also a supplier group. The bargaining power of strong labor unions has been a perennial
The key additions in assessing the power of labor are its degree of organization, and whether the supply of sca
organized or the supply of scarce labor is constrained from growing, the power of labor can be high.
Bargaining power of customers (affects price)

If you have powerful buyers (that is, customers), they will use their clout to force prices down. They may also dema
case, industry profitability will be lower because customers will capture more of the value for themselves
Consider the cement industry. In the United States, big, powerful construction companies account for a large perce
bargain for low prices, thus dampening the profit potential for the industry. Now let’s cross the border to Mexico, w
small, individual customers. Thousands of these “ants,” as they are called, are served by a handful of large produce
returns in Mexico, and not because it creates more value in its home market. In effect, CEMEX is competing in two
When you assess buyer power, the channels through which products are delivered can be as important as the end
purchase decisions of the end-user customers. Investment advisors, for example, have enormous power, and the h
powerful retailers like Home Depot and Lowe’s has put enormous pressure on the makers of home improvement p
Within an industry there may be segments of buyers with more or less negotiating power, and with greater or lesse
negotiating leverage if they are price sensitive. Both industrial customers and consumers tend to be more price sen
relative to their other costs or income ,Inconsequential to their own performance
A movie camera, for example, is a highly differentiated piece of equipment. Its price is small relative to the other co
impact on the success of the movie. Here quality trumps price.
It is high when buyers are:
Concentrated and purchases large volumes from the sellers
Product it purchases represent significant fraction of buyers cost of purchases
Product it purchases is undifferentiated with low switching cost
Earning low profits
Suppliers to Chrysler, for example, are complaining that they are being pressured for superior terms.
Can intergrate backwards
GM and Ford, they engage in the practice of tapered integration, that is, producing some of their needs for
suppliers. Not only is their threat of further integration particularly credible, but also partial manufacture in
aid in negotiation. Buyer power can be partially neutralized when firms in the industry offer a threat of forw
Indifferent regarding the quality of input on the final output of their product
Oil-field equipment, where a malfunction can lead to large losses (witness the enormous cost of the recent
preventor in a Mexican offshore oil well), and enclosures for electronic medical and test instruments, wher
impression about the quality of the equipment inside.
Have full knowledge of product
Retailers can gain significant bargaining power over manufacturers when they can influence consumers' pu
appliances, sporting goods, and other products. Wholesalers can gain bargaining power, similarly, if they ca
which they sell.
Threar of substitues (affects price)

Substitutes—products or services that meet the same basic need as the industry’s product in a different way—put
Sugar producers confronted with the large-scale commercialization of high fructose corn syrup, a sugar substitute,
and rayon who faced extreme competition from alternative, lower-cost materials for many of their respective appli
In 1978 the producers of fiberglass insulation enjoyed unprecedented demand as a result of high energy costs and
tempered by the plethora of insulation substitutes, including cellulose, rock wool, and styrofoam. These substitutes
the current round of plant additions has boosted capacity enough to meet demand (and then some).
Tax preparation software, for example, is a substitute for a professional tax preparer such as H&R Block.
OPEC, the Organization of the Petroleum Exporting Countries, has fended off substitutes by carefully managing the
Switching costs play a significant role in substitution. Substitutes gain ground when buyers face low switching costs
with moving from a branded drug to a generic one. Given that coffee drinking is such a deeply ingrained habit, it’s n
young.
Coinstar’s Redbox—the kiosk that dispenses movie rentals for just $1—has become a tangible threat to Hollywood’
Redbox is a substitute for buying videos, and it is a direct rival to local video rental stores that can’t match the conv
Substitute products that deserve the most attention are those that (1) are subject to trends improving their price-p
produced by industries earning high profits.
In the security guard industry, for example, electronic alarm systems represent a potent substitute. Moreover, they
services face inevitable cost escalation, whereas electronic systems are highly likely to improve in performance and
firms is probably to offer packages of guards and electronic systems, based on a redefinition of the security guard a
systems across the board.
Threat of new entrants (affects price)

Entry barriers protect an industry from newcomers who would add new capacity.
Companies entering an industry through acqusition often have the resources to shake up an industry- should be co
There are seven major barriers to entry - economies of scale, product differentation, capital requirements, switchin
1) Economies of scale:
Scale economies in production, research, marketing and service are key barriers to entry in the mainframe
In manufacturing of TV sets the scale economies are in color tube production and not in cabinetmaking and
For example, scale economies in production, research, marketing, and service are probably the key barriers
General Electric sadly discovered.
Multibusiness company may produce small electric motors which may be used in producing industrial fans,
Potentially shareable activities which give economies of scale can be - sales force, distribution, purchasing a
Joint costs - firm producing product A must have the potential to produce product B- Air freight and Air pas
This same sort of effect occurs in businesses that involve manufacturing processes involving by-products. T
revenue from the by-products can face a disadvantage if incumbent firms do.
Situations in which business units can share intangible assets and economies of scale from vertical integrati
In industry after industry, Porter notes that economies of scale are exhausted at a relatively small share of
General Motors was the world’s largest car company for a period of decades, a fact that didn’t preven
all, it might be more accurate to say that GM was too big to succeed. Meanwhile, BMW, small by indu
decade (2000–2009), its average return on invested capital was 50 percent higher than the industry a
Companies only have to be “big enough,” which rarely means they have to dominate. Often “big enou
influence of winner-takes-all thinking tend to pursue illusory scale advantages. In doing so, they are li
volume, by overextending themselves to serve all market segments, and by pursuing overpriced merg
decades has exhibited all of the above tendencies, to disastrous effect.
The winner-takes-all model presupposes incorrectly that there is one scale curve in an industry and th
that all rivals are competing to offer the universally best product or service. In practice, most industrie
needs.
2) Product Diffferentation
Forces entrants to spend lavishly to overcome existing customer loyalties
The most important barrier in baby care products, OTC drugs, cosmetics, investment banking and accountin
In the brewing industry, product differentiation is coupled with economies of scale in production, marketin
3) Capital requirements
If capital is required for risky and unrecoverable upfront activities like advertising and R&D
Capital may also be required for customer credit, inventories or covering start up losses
Xerox created barriers to entry when it started renting copier machines creating severe working capital req
The huge capital requirements in fields like computers and mineral extraction limit the pool of likely entran
represents a risky use of that capital which should be reflected in risk premiums charged the prospective en
4) Switching costs
Switching costs may include employee retraining costs, cost of new ancillary equipment, cost and time in te
of reliance on seller engineering aid, product redesign, or even psychic costs of severing a relationship
For example, in intravenous (IV) solutions and kits for use in hospitals, procedures for attaching solutions to
hanging the IV bottles are not compatible. Here switching encounters great resistance from nurses respons
in hardware.
5) Distribution channels
The new firm must persuade the channels to accept its product through price breaks, cooperative advertisi
Sometimes this barrier to entry is so high that to surmount it a new firm must create an entirely new distrib
6) Cost advantages independent of scale
Technology, raw material access, locations, government subsisidies, learning curve
Frasch sulphur firms like Texas Gulf Sulphur gained control of some ver favorable large salt dome sulphur d
their value as a result of the Frasch mining technology. Discoverers of sulphur deposits were often disappo
value them highly.
Experience can lower costs in marketing, distribution, and other areas as well as in production or operation
examined for the effects of experience.
Cost declines with experience seem to be the most significant in businesses involving a high labor content p
and/or complex assembly operations (aircraft manufacture, shipbuilding).
Texas Instruments, Black and Decker, Emerson Electric, and others have built successful strategies based on
cumulative volume early in the development of industries, often by pricing in anticipation of future cost de
Economies of scale are dependent on volume per period, and not on cumulative volume, and are very diffe
together and can be hard to separate.
Goverment policy can also create barriers to entry
Expiration of Polaroid's basic patents on instant photography, for instance, greatly reduced its absolute cost entry b
Kodak plunged into the market. Product differentiation in the magazine printing industry has all but disappeared, re
scale increased with post-World War II automation and vertical integration, virtually stopping successful new entry
The actions of many U. S. wine producers in the 1960s to step up introductions of new products, raise advertising le
barriers by raising economies of scale in the industry and making access to distribution channels more difficult. Sim
vertically integrate into parts manufacture in order to lower costs have greatly increased the economies of scale th
Some firms may possess resources or skills which allow them to overcome entry barrier into an industry more chea
developed distribution channels for razors and blades, faced lower costs of entry into disposable lighters than did m
opportunities for low-cost entry
Competition between existing players (affects price and cost)

Rivalry among existing competitors takes the familiar form of jockeying for position—using tactics like price compe
customer service or warranties.
If rivalry is intense, companies compete away the value they create, passing it on to buyers in lower prices or dissip
In most industries, competitive moves by one firm have noticeable effects on its competitors and thus may incite re
dependent.
Price competition can make the whole industry worse, in contrast advertising competition can make the whole indu
When firms are numerous making independent moves is more feasible, when it is concentrated the leader can imp
In many industries foreign competitors, either exporting into the industry or participating directly through foreign i
Market share competition is inherently more volatile instead of when there is rapid industry growth
High fixed or storage costs creates pressure to lower costs
Many basic materials like paper and aluminum suffer from this problem, for example
A situation related to high fixed costs is one in which the product, once produced, is very difficult or costly to
This sort of pressure keeps profits low in industries like lobster fishing and the manufacture of certain ha
Lack of product differentiation and switching costs creates pressure to lower prices
When capacity is added in large increments it can lower the profitability of entire industry
The industry may face recurring periods of overcapacity and price cutting, like those that afflict the manufactu
Diverse competitors may create situations when the companies run into each other - each may have a different ide
High exit barriers can mean that companies will keep on competiting even if ROIC is low - specialized assets, fixed c
In the booming recreational vehicle industry of the early 1970s nearly every producer did well, but slow growth sin
competitors, not to mention forcing many of the weaker companies out. The same story has been played out in ind
equipment are just a few examples.
Competitive advantage
Taking offensive or defensive action to minimize the five forces
Innovations in marketing can increase product differentiation
Capital investments in large scale projects or vertical integration can create entry barriers
Three generic strategies : cost leadership, differentiation, focus (niche)
A low-cost position protects the firm against all five competitive forces because bargaining can only continue to
eliminated, and because the less efficient competitors will suffer first in the face of competitive pressures.
Approaches to differentiating can take many forms: design or brand image (Fieldcrest in top of the lin towels and
Macintosh in stereo components; Coleman in camping equipment), features (Jenn-Air in electric ranges); custom
(Caterpillar Tractor in construction equipment), or other dimensions.
Differentiation provides insulation against competitive rivalry because of brand loyalty by customers and resultin
the need for a low-cost position. The resulting customer loyalty and the need for a competitor to overcome uniq
with which to deal with supplier power, and it clearly mitigates buyer power, since buyers lack comparable alter
has differentiated itself to achieve customer loyalty should be better positioned vis-à-vis substitutes than its com
Focus means you have a low cost position with your target customer or differentiation or both (Mungers niche in
Stuck in the middle firm loses profitability
Competitor Analysis - Soul, Skeleton, Skin analysis of the comeptitor
Competitive advantage is about how your value chain will be different and your P&L better than the industry avera
Five tests of strategy
unique value proposition a company offers its customers - what customers - what needs - what relative
is different from your rivals. If you are trying to serve the same customers and meet the same needs and
don’t have a strategy
value proposition will translate into a meaningful strategy only if the best set of activities to deliver it is d
advantage lies in the activities, in choosing to perform activities differently or to perform different activi
a successful strategy will attract imitators, choices that are difficult to copy are essential.
Trade-offs are the economic linchpins of strategy for two reasons. First, they are an important sour
make it difficult for rivals to copy what you do without compromising their own strategies.
Good strategies depend on the connection among many things, on making interdependent choices. A co
core activities and to outsource the rest. Fit challenges that bit of conventional wisdom.
Companies can change too much, and in the wrong ways. It takes time to develop real competitive adva
trade-offs, and fit. If you grasp the role of continuity in strategy, it will change your thinking about chang
If you have a real competitive advantage, it means that compared with rivals, you operate at a lower cost, comman
The financial measure that best captures this idea is return on invested capital (ROIC)
Market share says we just want to be big; we don’t care if we make money doing it. That’s what misled much
to get an additional 5 percent of the market, some companies increased their costs by 25 percent. That’s reall
In gauging competitive advantage, then, returns must be measured relative to other companies within the sam
similar configuration of the five forces.
A company can sustain a premium price only if it offers something that is both unique and valuable to its customers
prices. Ditto for the high-speed Madrid-to-Barcelona train and the trucks Paccar creates for owner-operators. Creat
to pay (WTP), the mechanism that makes it possible for a company to charge a higher price relative to rival offering
A consumer’s WTP is more likely to have an emotional or intangible dimension, whether it is the trust engend
the latest electronic gadget. Automakers are betting that consumers will pay a price premium for hybrid cars t
Clearly, noneconomic factors are at work in this calculation
Differentiation refers to the ability to charge a higher relative price.
The second component of superior profitability is relative cost—that is, you manage somehow to produce at lower
ways to create, produce, deliver, sell, and support your product or service.
Strategy choices aim to shift relative price or relative cost in a company’s favor.
The sequence of activities your company performs to design, produce, sell, deliver, and support its products is calle
1. Start by laying out the industry value chain.
R&D - Supply Chain - Operations - Sales & Marketing - After sales service
How far upstream or downstream do the industry’s activities extend?
What are the key value-creating activities at each step in the chain?
Compare the value chains of rivals in an industry to understand differences in prices and costs
2. Next, compare your value chain to the industry’s.
3. Zero in on price drivers, those activities that have a high current or potential impact on differentiation.
4. Zero in on cost drivers, paying special attention to activities that represent a large or growing percentage
You begin to see each activity not just as a cost, but as a step that has to add some increment of value to the finishe
Difference in relative price or relative costs that arises because of differences in the activities being performed
Betting that you can achieve competitive advantage—a sustainable difference in price or cost—by performing the s
has been better at OE (operational effectiveness) competition than the Japanese, but, as Porter’s work documents
chronically poor profitability.
ent of scale, network effects
s, government restrictions
rger value system.

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1

What are some barriers to entry?

Specialization - Adam's smith pin factory

cisions time after time.”

Is the business’s balance sheet strong or weak?

Five ways a company can increase earnings:

ure cash flows are revised.

Braun's Five W's: Who, what, where, when and why.

A firm with a strong financial team has several important advantages:

First, arouse in the other person an eager want.

t other people's interest

appeal to interest and not to reason

in and fear of loss

ur product should be so great that you ought to be using it

mething associated with

ur best interest or in the

e power in giving people reasons

Competing to be the best feeds on imitation. Competing to be unique thrives on innovation.

Typical steps in industry structure analysis:

Bargaining power of suppliers (affects cost)

Bargaining power of customers (affects price)

Threar of substitues (affects price)

Threat of new entrants (affects price)

Competition between existing players (affects price and cost)

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