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Optimal gameplan for running a commodity business?


premfan
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Hi guys,

 

In my opinion 99 plus percent of business's are a  commodity business. According to Buffet's labeling of a economic franchise. Which is a needed or desired product/service. A product or service that has no close substitute and is not subject to price regulation. This leaves extremely few business's that can truly be labeled a franchise. My question is knowing that you are running a commodity business or say owning a company that's in commodity business whats the optimal gameplan?

 

Most people would say be the lowest cost producer of the commodity. This is easier said than done. In most business's you need economics of scale to truly lower operating expenses relative to your competitors.

 

In a fragmented industry i think the company "might" have a chance to consolidate and turn into a regional franchise. Or worse case own a higher market share of a fragmented industry which should lower operating expense and create a competitive advantage. In a saturated market i'm not seeing  a way a commodity  company can thrive. In a saturated industry there might be  "perfect" competition and everyone essentially gets the same slice of the pie.

 

So knowing that most business's are a commodity whats the best way to decommoditize( dont know if thats a word) your business? Avoid saturated markets in general?

 

 

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Hi guys,

 

In my opinion 99 plus percent of business's are a  commodity business. According to Buffet's labeling of a economic franchise. Which is a needed or desired product/service. A product or service that has no close substitute and is not subject to price regulation. This leaves extremely few business's that can truly be labeled a franchise. My question is knowing that you are running a commodity business or say owning a company that's in commodity business whats the optimal gameplan?

 

Most people would say be the lowest cost producer of the commodity. This is easier said than done. In most business's you need economics of scale to truly lower operating expenses relative to your competitors.

 

In a fragmented industry i think the company "might" have a chance to consolidate and turn into a regional franchise. Or worse case own a higher market share of a fragmented industry which should lower operating expense and create a competitive advantage. In a saturated market i'm not seeing  a way a commodity  company can thrive. In a saturated industry there might be  "perfect" competition and everyone essentially gets the same slice of the pie.

 

So knowing that most business's are a commodity whats the best way to decommoditize( dont know if thats a word) your business? Avoid saturated markets in general?

 

Go niche.  Reduce the market to such a small and narrow subset that your competitors can't be bothered to react and that your value proposition is much more focused and specific.  You can charge a premium because you are delivering exactly what your customers want, rather than a broader set of services that they may or may not want.  Once you've saturated the niche market you can expand to other, related markets.

 

The best book I ever read on this subject was The Discipline of Market Leaders:

http://www.amazon.com/The-Discipline-Market-Leaders-Customers/dp/0201407191

 

 

 

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I think commodity vs franchise/moat/competitive advantage is a gradation not black and white. Most business have limited competitive advantages which they try to grow over time.

 

Competitive advantage is highly influenced by sector and this effect is fairly stable over time. You will find many healthcare businesses with significant competitive advantages but few coal companies. You can identify these sectors and businesses by their high long term ROIC. They have lower fixed capital intensity and higher human capital intensity than commodity businesses.

 

Personally I find it useful to concentrate on a few sectors where high ROICs are concentrated: technology, healthcare, consumer brands, media, financial services, etc.

 

Outside of finding another business, some of the strategies for pure commodity companies would include moving up the value chain (for example, through superior service, consumerization or financialization). And horizontal or vertical integration.

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My gameplan (Life's too short to own a bad business.)

1) Close or sell business and invest money into a quality business at a good price.

Or

2) Hire management with realistic strategy to improve business and properly incentivize. With a commodity businesses, it seems easy to fool oneself about ones ability to improve the business. Awareness of context of the industry seems important...  This seems to be happening with Klarman and Micron-- http://www.dataroma.com/m/holdings.php?m=BAUPOST Plus, awareness of industry cycles.

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This seems to be happening with Klarman and Micron-- http://www.dataroma.com/m/holdings.php?m=BAUPOST Plus, awareness of industry cycles.

 

Weird.  I thought about shorting Micron and it has high-ish short interest so I'm not the only one thinking that.  The history of semiconductor manufacturing is ugly and highly cyclical.  Their end products are mostly commodities.  There are some advantages from economies of scale, but the industry dynamics are awful as the industry is very cutthroat.  Flash memory is a commodity business that is close to the top of its cycle.  The profits will attract overcapacity.

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Thank you for the replies and book recommendation

 

How to not become a commodity business gameplan

 

1.) Niche markets with high ROIC

2.) Avoid saturated markets like the plague

3.) Look for  large companies in a niche market with ROIC. The large company most likely has economics of scale and has lower operating expense to competitors. This creates a "moat" in a commodity business.

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Actually one of the most interesting prospects for investing in a commodity business is to find what I have gotten in the habit of referring to as a fulcrum investment. 

 

Take the oil & gas / petrochemicals sector for example.  You look at where prices and expectations are for oil and gas, and you look at businesses that are not economic at those price level – i.e. relatively high cost producers.  If they are significantly uncompetitive, the assets will be stacked / mothballed.  If prices rise those assets will be activated and become economic.  The parallels to call options should jump out at you.  On top of all this, you have to have some sort of view on future commodity prices or at least their future potential movement / volatility. 

 

Some of the most amazing examples of this that I am aware of are in the chemicals space which is a bit downstream for my interest.  In the mid to late 2000s some individuals bought cold-idle facilities that were rather old and uneconomic (in Texas if I recall right, but if not, somewhere else in the US).  Subsequent to the shale revolution getting into full gear, post 2009, which resulted in a massive decrease in US nat gas prices relative to global crude oil prices, US chemical plants have an absolute cost advantage (as they use nat gas / NGLs as a primary feedstock) over most ex-US competition.  Some of these plants that were purchased 5 – 10 years ago for $50MM - $100MM are worth billions now—privately held in some cases, but the owners are monetizing those gains with $1Bn+ debt deals. 

 

I think if you buy a commodity business that is currently mothballed you can create a very convex position that could work to your benefit, as opposed to buying a fully performing facility (with no moat in either case) where you may have a much more concave exposure.  (There is a parallel about the potential attractiveness of distressed debt relative to most par lending here.) 

 

 

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Barbell,

 

There is a phosphate play (fos) which meets the basic criteria you are looking for.  Essentially you have a company sitting on a phosphate claim waiting for prices to pick up.  The company is selling for below net cash.  Management seems patient and is just waiting it out and reducing costs.  I started a thread on this board about it if you are interested.

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