Moats can be weaker than they seem - Ebay in China
For someone who is value-oriented, I seem to be one of the few who is always skeptical of moats and is in fact scared of paying too much for them. For those not familiar, moats, originally popularized by Warren Buffett, is the notion of a business having very high barriers to entry.
If there is one thing that value investors are vulnerable to, it is the notion of moats. Based on my non-scientific observations, I feel that many value investors overpay for moats. Even worse, what is perceived as a strong moat often dissapears within a decade and I think the moats are mirages. I want to illustrate the case of Ebay in China.
I am sure most would agree that Ebay has a huge moat—I agree with that view as well. But consider what happened in China—admittedly this is a narrow market and my argument is not reflective of Ebay as a whole. The example is based on a New York Times story about TaoBao.
According to the story in the New York Times, Taobao is an online website, somewhat similar to Ebay, that matches buyers with sellers. Unlike Ebay, it does not charge the merchants or the buyers anything. It makes all its money from advertising. Some may question the sustainability of that business model but let's ignore that point for now (we are not concerned with Taobao.) It generated around $15 billion in merchant sales (not sure what the company itself earned.)
The story describes what happened within a few, quick, years:
If you were investing in, say, 2005, what would you have thought of the Chinese market place? I suspect most would have said that there was little chance of dislodging Ebay and its EachNet partner from the market. After all, here you have an American giant with a proven record and millions in cash that can be deployed in the joint-venture, which already had 90% of the market share.
Admittedly the moat of the joint-venture wouldn't have been that strong given how they have only been operating for a few years, and online retailing and auction is a rapidly changing new industry. Nevertheless, I think most would have perceived some sort of a moat.
Yet, it ended up with Ebay posting huge losses and completely withdrawing from the market. You owned 90% of the market share but now your competitor owns 80% of the market.
I don't see too many people arguing that Internet companies have huge moats (although I do think companies like Amazon, Ebay and Google have big moats.) I certainly don't see value-oriented investors paying up for Internet moats. However, I do see many paying up for moats of companies like Coca-Cola, American Express, P&G, Pfizer, and Wal-mart. I have nothing against these companies and don't even follow them but make sure that you are not overpaying for the moat. Can the moats of these companies be breached? I don't know; it's something you should think about if you are paying up for them.
If there is one thing that value investors are vulnerable to, it is the notion of moats. Based on my non-scientific observations, I feel that many value investors overpay for moats. Even worse, what is perceived as a strong moat often dissapears within a decade and I think the moats are mirages. I want to illustrate the case of Ebay in China.
I am sure most would agree that Ebay has a huge moat—I agree with that view as well. But consider what happened in China—admittedly this is a narrow market and my argument is not reflective of Ebay as a whole. The example is based on a New York Times story about TaoBao.
According to the story in the New York Times, Taobao is an online website, somewhat similar to Ebay, that matches buyers with sellers. Unlike Ebay, it does not charge the merchants or the buyers anything. It makes all its money from advertising. Some may question the sustainability of that business model but let's ignore that point for now (we are not concerned with Taobao.) It generated around $15 billion in merchant sales (not sure what the company itself earned.)
The story describes what happened within a few, quick, years:
When Taobao was founded in 2003, it looked as if it did not have a chance. EBay and its Chinese partner, EachNet, controlled 90 percent of the Chinese online shopping market. But Mr. Ma, a former English teacher, quickly undermined eBay’s fee-based service by offering free listings on Taobao, essentially giving free ads to anyone who wanted to sell. At the time, eBay executives ridiculed the strategy, saying, “Free is not a business model.”
But almost immediately, the site took off, and in 2006, eBay pulled out of China, citing dwindling market share and huge losses. Today, it is Taobao that commands 80 percent of the Chinese e-commerce market, according to iResearch.
If you were investing in, say, 2005, what would you have thought of the Chinese market place? I suspect most would have said that there was little chance of dislodging Ebay and its EachNet partner from the market. After all, here you have an American giant with a proven record and millions in cash that can be deployed in the joint-venture, which already had 90% of the market share.
Admittedly the moat of the joint-venture wouldn't have been that strong given how they have only been operating for a few years, and online retailing and auction is a rapidly changing new industry. Nevertheless, I think most would have perceived some sort of a moat.
Yet, it ended up with Ebay posting huge losses and completely withdrawing from the market. You owned 90% of the market share but now your competitor owns 80% of the market.
I don't see too many people arguing that Internet companies have huge moats (although I do think companies like Amazon, Ebay and Google have big moats.) I certainly don't see value-oriented investors paying up for Internet moats. However, I do see many paying up for moats of companies like Coca-Cola, American Express, P&G, Pfizer, and Wal-mart. I have nothing against these companies and don't even follow them but make sure that you are not overpaying for the moat. Can the moats of these companies be breached? I don't know; it's something you should think about if you are paying up for them.
Good cautionary words for someone who believes in "moat magic." However, moats of moated companies producing physcial goods can't be eroded by giving said goods away. Read narrowly, the above case study says that moats are vulnerable only to the "power of Free."
ReplyDeleteI sort of disagree. I think you can lose your moat even if you are dealing in a different industry with physical goods.
ReplyDeleteConsider newspapers. They had a massive moat and it depended on physical papers. Not only did the Internet shatter their moats, major metropolitan cities also have free commuter papers these days. Many would probably have said that it was impossible to give away paper for free and survive yet the free commuter papers seem to survive.
I have been researching Lexmark, a printer company, and consider their industry. Printer companies made money off printers. Nowadays, they generally don't (it depends on which portion of the indusry you are looking at but let's say we look at consumer printers.) Most printer companies sell their printers at a loss. It's not free but it's the equivalent of being free for a physical good. The printer companies make their money off ink cartridges and services. Twenty years ago, if someone said a printer company is selling printers at a loss, many would have said it was crazy and unsustainable.
I didn't consider those examples, so I stand partially corrected. Nevertheless, "free" is the main moat-breacher unless a moat company falls apart on its own. (!) Unless there's a way to make free pay, a moat isn't that scalable.
ReplyDeleteIf you're interested, the printer companies are using a similar strategy to a well-known moat company, Gillette. When King Gillette started up the company, he gave away razor holders and sold the razors. So did the cell phone providers back in the day.
Actually, in retrospect, it may be smarter for the printer companies to give the printers away outright. Selling at a loss means "loss leader," but giving stuff away does engender a sense of reciprocal obligation on the part of the receiver. Such as the obligation to not buy those refill cartridges on eBay, or the generic ones in Staples.