Buffet’s Concept of “Durable Competitive Advantage”

Buffet's Selective Contrarian Investment Philosophy is based on his concept of "low-cost durable competitive advantage". In this article I will examine just what he means by these two terms: "competitive advantage", and "durable".

By "competitive advantage" Buffet means a unique product or service that a business either makes or provides. That competitive advantage lies not in the people who compose the business. Rather it is inherent in the product or service itself. The employees can walk away from the business but they cannot take the business's "competitive advantage" with them. Examples of a business's "competitive advantage" might be the business's brand name, for instance, YUM's Taco Bell, Pizza Hut, or Kentucky Fried Chicken. Or, it could be a regional monopoly such as a town that has only one newspaper that you must use if you are to advertise your products. Other examples of businesses that have "competitive advantages" are Hershey's Chocolate, Dun and Bradstreet's Moody's Investor Services, and Coca-Cola, to name a few.

All businesses that have a durable competitive advantage share the following characteristics in common:

• They have been in business for years
• They have made the same product or given the same service for years
• They will more than likely continue to make the same product into the future
• They spend little money on R& D
• They have no need to retool their production plant to make new products
• Their unique product or service has a long life span in the marketplace
• They serve a repetitive need
• Their product or service is fairly simple

Another thing about the "competitive advantage" inherent in a business: Its unique product or service makes it possible for it to earn monopoly-like profits. Why? Because it is calling the shots as to how the game will be played. It is in control. Thus, it is able to charge higher prices, which translate to higher margins, which, in turn, mean greater profits for its shareholders.

One final thing about a business's "competitive advantage" is that it protects the business from competition. No business can under sell them simply because no one else can sell their product but them. Or, to put it more clearly, no one can compete with Kentucky Fried Chicken by way of price or market share simply because no one can sell KFC but KFC.

Competitive advantage, however, for Buffet is NOT enough. It must also possess a competitive advantage that is DURABLE, What he means by "durable" is that the business must be able to keep its competitive advantage far into the future without having to invest large amount of capital to maintain it. That is to say that a "durable competitive advantage" business should not have to invest a whole heap of money in R & D to come up with ideas for new products. Nor should it have to spend a huge amount of capital to re-tool its production plant to create new products. Hershey's Chocolate is a case in point. It hasn't changed in over 70 years! How much money do you think that it invested in R&D? How much money did it have to invest to re-tool its manufacturing plant? Not much. Hershey's has been making and selling the same products for years and will doubtlessly be doing the same thing well into the future. Because of this, "durable competitive advantage" companies like Hershey's operate at a low cost relative to other businesses that don't have a "durable competitive advantage". That being so, "durable competitive advantage companies can pass on their saving to their shareholders, and their investors can easily predict their earning potential.