Durable competitive advantage: Why Buffett likes food and drinks

February 25th, 2013

We know that Warren Buffett likes to buy companies that have such a competitive advantage in the market that it is like a moat protecting a castle. A business with this competitive edge would have all or most of the following attributes:

  • an easily recognized brand name (or brand names)
  • a predominant share in a market or market segment
  • a product that people need or want to buy over and over, and
  • a place in a market that is not easy to enter.

Berkshire Hathaway and Buffett have in the past put a lot of money into things that we eat and drink. They continue to do so because many companies in this field have a moat. Berkshire’s latest acquisition in Heinz is no exception.

At first glance the markets in which these companies operate seem highly competitive. The food and drink businesses in the Berkshire portfolio all have competition for their products, not only from other brand name manufacturers (Coca Cola and Pepsi, Heinz and Campbell) but from the home brands of grocery chains. However, in a competitive market, it is possible for businesses to occupy a place that, because of their name, the nature of the product and customer preference,  still gives them that competitive edge. This is because customer loyalty, sometimes bordering on fanaticism, creates a monopoly for that group of customers.

Take the hamburger industry. You can buy hamburgers anywhere, but there is a large segment of the hamburger-consuming market that will only eat McDonalds and for whom McDonalds is a life-long eating passion. These people will keep producing profits for McDonalds day in and day out for the foreseeable future.

Look at the cola market where the world is divided between Coke drinkers, Pepsi drinkers and the rest. The loyal Coca-Cola drinker will continue to drink Coke in preference to the others no matter what, will continue to buy it even if the price goes up a few cents, and this attitude ensures that retail outlets will always stock it. This has been happening for many years and should continue for many more, unless some foolish CEO, wanting to fix something that works well, decides to change the recipe. (You can read about the New Coke debacle in Mark Pendergrast’s history of the Coca Cola company – For God, Country, and Coca-Cola: The Definitive History of the Great American Soft Drink and the Company That Makes It).

This type of thinking has seen Buffett buy stock over the years, not only in Coca Cola and Pepsico (which has Frito-Lays and other brand name snack foods as well as Pepsi) but in businesses like Yum Foods (KFC, Taco Bell and Pizza Hut), See’s Candies, Anheuser-Busch (Budweiser), Wrigley and Hershey: all companies with brand-name foods or drinks, all within a competitive market (fast food, snack food, alcoholic drinks, non-alcoholic drinks) but which, because of customer preference and loyalty built up over many years, occupy a position within that market that has a moat.

This reasoning applies to food companies like Campbells and Heinz, both of which have attracted Buffett’s interest over the years (Heinz now in a very big way). There are several brands of canned soup, baked beans, spaghetti and the like on the market but there are segments of the population who will only buy Heinz or Campbells and will go on buying them forever. Try putting a ketchup other than Heinz on the hamburger of a Heinz fan and sit back for the complaints. And on this basis, the Heinz takeover makes sense, although Berkshire has probably paid top price.

Companies like these, although in price-competitive markets, can also generally raise the price of their products gradually to cover inflation and rising production costs without losing customers. And they are big enough not to be taken advantage of by the large supermarket chains.

But remember that Buffett only buys into these companies when they satisfy all his other investment guidelines and when he can buy at the right price. And he will sell, despite his preference to own stock in a company forever, when the company ceases to hold its value and when he can put the money invested in it to better use.

Posted by Julian Livy on February 25th, 2013 | Posted in How Buffett invests |