Industries with moat and going downhill

An example of an industry going downhill

In Berkshire’s shareholder letter in 1991, Buffett wrote that the media industry is going downhill and its moat (aka economic competitiveness) is not as good as before:

In last year’s report, I stated my opinion that the decline in the profitability of media companies reflected secular as well as cyclical factors. The events of 1991 have fortified that case: The economic strength of once-mighty media enterprises continues to erode as retailing patterns change and advertising and entertainment choices proliferate. In the business world, unfortunately, the rear-view mirror is always clearer than the windshield: A few years back no one linked to the media business – neither lenders, owners nor financial analysts – saw the economic deterioration that was in store for the industry. (But give me a few years and I’ll probably convince myself that I did.)

The fact is that newspaper, television, and magazine properties have begun to resemble businesses more than franchises in their economic behavior. Let’s take a quick look at the characteristics separating these two classes of enterprise, keeping in mind, however, that many operations fall in some middle ground and can best be described as weak franchises or strong businesses.

Note 1: Please note; Buffett is using the term “franchise” to refer to competitive businesses. The word “moat” had to wait two years before it first appeared in Berkshire’s shareholder letter in 1993.

Note 2: The internet is now recognized as being invented in 1983, so in 1991, Buffett felt that the media industry was going downhill, and the competitiveness was not as good as before. But Buffett did not point to the apparent decline of the media industry as a result of the Internet at this time.

The characteristics of an industry with moat

An economic franchise arises from a product or service that:

  • (1) is needed or desired;
  • (2) is thought by its customers to have no close substitute and;
  • (3) is not subject to price regulation.

The existence of all three conditions will be demonstrated by a company’s ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital. Moreover, franchises can tolerate mis-management. Inept managers may diminish a franchise’s profitability, but they cannot inflict mortal damage.

Ways for companies to get high returns

In contrast, “a business” earns exceptional profits only if it is the low-cost operator or if supply of its product or service is tight. Tightness in supply usually does not last long. With superior management, a company may maintain its status as a low-cost operator for a much longer time, but even then unceasingly faces the possibility of competitive attack. And a business, unlike a franchise, can be killed by poor management.

Note: All oil and energy companies in the world set record high profits in 2022. The main reason is the imbalance between energy supply and demand.

Internet media began to threat old media

Until recently, media properties possessed the three characteristics of a franchise and consequently could both price aggressively and be managed loosely. Now, however, consumers looking for information and entertainment (their primary interest being the latter) enjoy greatly broadened choices as to where to find them. Unfortunately, demand can’t expand in response to this new supply: 500 million American eyeballs and a 24-hour day are all that’s available. The result is that competition has intensified, markets have fragmented, and the media industry has lost some – though far from all – of its franchise strength.

Related content in my book

In my book “The Rules of Super Growth Stocks Investing“:

  • In subsection 2-2, pages 84-93: Take Microsoft (Uticker: MSFT) and Apple (ticker: AAPL) to illustrate what kind of companies are the franchise businesses in Buffett’s eyes.

There is no permanent moat

As Buffett emphasized at the 2021 Berkshire shareholder meeting: “None of the top 20 stocks in the world 32 years ago are still on the list.

There are indeed monopoly in this world“, because there cannot be a permanent moat in this world. For the reason, please refer to my previous blog article “How do monopolies or oligopolies work in the real world?


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