Rule Breakers and Rule Makers by David and Tom Gardner

[ratiman]

This is a book from 1998/9  that lays out the Fool strategy for Rule makers (AOL, Amazon, Starbucks, Whole Foods) (companies that disrupt/create new consumer industries), Rule Makers (Coke, Microsoft, Disney) (indispensable consumer products) and Tweeners (Iomega, Yahoo). It's well done. The Gardner brothers are related to the Gardner in the Gardner, Russo, Gardner firm, so they grew up talking stocks. They also know a great deal about branding and marketing, as they turned their little website into a big brand in the 90s and now into a mutual fund company.

 

It's interesting to look back now and see what the Fools got right and wrong. Here is a list of the Rule Makers, the established firms with dominant monopolies:

 

Coke

Disney

GAP

Intel

Microsoft

Nike

Dell

 

The book was written in 1998/1999, so many of these stocks and companies were at a peak. Coke is still below the April 98 high. GAP and Intel and Microsoft haven't returned to former glory. Only Disney and Nike are at new highs. I don't know the lesson to draw from that. The success of ESPN and Pixar and Marvel and Star Wars was not foreordained.

 

The Fools (Gardners) come up with a good rule for a stock that's between a Rule breaker and a Rule maker: if you can imagine life without the product, then it is a Tweener. If there is an acceptable substitute and competitor, then the transition from Rule Breaker to Maker is in doubt. Yahoo is convenient but Google is indispensable. At the time, Dell was considered a Rule Maker, having graduated to a stable, dominant business, but we now know that Dell was not indispensable. Amazon turned out to be indispensable. Is Starbucks indispensable? Are there no acceptable substitutes? The Gardners explain the success of Starbucks in terms of brand, but I'm not sure that's the best explanation.

 

If the Fools have any bias, it's that they overvalue consumer brand. Brand is certainly important in consumer packaged goods. Coke, Cheerios, Gillette, etc. But brand wasn't able to save AOL, Yahoo, or GAP. Steve Case learned all about branding at P&G but ultimately AOL didn't have the magic sauce, Facebook did. Brand alone isn't going to create a dominant monopoly. Cheerios is not the only cereal.

 

If this book were to be written today, it would probably focus on networks and not brands. Facebook, Google, Amazon, eBay, Netflix, Uber, Microsoft, etc can all be thought of as networks/marketplaces that aggregate two sides and take a fee in the middle. It's interesting that the Fools were largely silent about eBay even as that was in many ways the business model of the future.

 

 

[ScottHall]

Hi Ratiman,

 

I wouldn't suppose to speak for Tom, but in my conversations with him and observation of his investing style, it seems to have morphed into one that's quite a bit closer to his brother's than it used to be. If you're interested in the Rule Breakers style, you can check out David Gardner's podcast. It's free.

 

http://www.fool.com/podcasts/rule-breaker-investing/

[ratiman]

Thanks for the link to the podcasts.

 

Here is a sentence that I think nicely frames the problem with the focus on brand:

 

"Whether you're talking about CPG companies like McDonalds or Nike, computer companies like Dell, or service companies like FedEx, brand is often the powerful differentiator that enables companies to attract, habituate, profit, and protect."

 

That seems wrong. Dell had no brand. For a brief moment it had monopoly profits due to a new distribution model. FedEx might at one point have relied on a brand, but now it has a duopoly with UPS. The only powerful brand of the four is Nike.

 

The Gardners argument is circular. Companies succeed because they have strong brands. And we know they have strong brands because they succeed. But in many cases the brand is secondary to other factors.

[ScottHall]

Thanks for the link to the podcasts.

 

Here is a sentence that I think nicely frames the problem with the focus on brand:

 

"Whether you're talking about CPG companies like McDonalds or Nike, computer companies like Dell, or service companies like FedEx, brand is often the powerful differentiator that enables companies to attract, habituate, profit, and protect."

 

That seems wrong. Dell had no brand. For a brief moment it had monopoly profits due to a new distribution model. FedEx might at one point have relied on a brand, but now it has a duopoly with UPS. The only powerful brand of the four is Nike.

 

The Gardners argument is circular. Companies succeed because they have strong brands. And we know they have strong brands because they succeed. But in many cases the brand is secondary to other factors.

 

I don't disagree with anything you said, just wanted to note the book was published 17 years ago so keep in mind their philosophies have undoubtedly evolved to some degree in the meantime.

[Jurgis]

Companies succeed because they have strong brands. And we know they have strong brands because they succeed.

 

Bingo!

 

That's what bothers me a lot with quite a few brand-is-a-moat arguments. You have to be very careful when such argument is used.

 

There are brands that survive and keep up their domination. But it's not assured just because it's a brand and it's successful now (or even for last 5-10-15 years).