Three basic business models to look for



How does Warren Buffett identify the exceptional companies? By looking for three basic business models, namely, they sell a unique product, they sell a unique service, or they are the low-cost buyer and seller of a product or service that the public consistently needs, inform Mary Buffett and David Clark in ‘ Warren Buffett and the Interpretation of Financial Statements' ( www.landmarkonthenet.com).

Among the examples of the first type are Coca-Cola, Pepsi, Wrigley, Hershey, Budweiser, and Philip Morris. The authors reason that through the process of customer need and experience, and advertising promotion, the producers of these products have placed the stories of their products in our minds and in doing so have induced us to think of their products when we go to satisfy a need.

“Warren likes to think of these companies as owning a piece of the consumer's mind, and when a company owns a piece of the consumer's mind, it never has to change its products… The company also gets to charge higher prices and sell more of its products, creating all kinds of wonderful economic events that show up on the company's financial statements.”

In the second model, that is, selling a unique service, are cited companies such as Moody's Corp., H&R Block Inc., American Express Co., and Wells Fargo & Co. The authors note that like lawyers or doctors, these companies sell services that people need and are willing to pay for. They remind that the economics of selling a unique service can be phenomenal. “A company doesn't have to spend a lot of money on redesigning its products, nor does it have to spend a fortune building a production plant and warehousing its wares.”

And, in the third model are examples such as Wal-Mart, Costco, Nebraska Furniture Mart, and the Burlington Northern Santa Fe Railway, where big margins are traded for volume, with the increase in volume more than making up for the decrease in margins. “The key is to be both the low-cost buyer and the low-cost seller, which allows you to get your margins higher than your competitor's and still be the low-cost seller of a product or service. The story of being the best price in town becomes part of the consumer's story of where to shop…”

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The ushering in of a world of shares

For as long as there has been money in the world there have been those who have wanted to invest it, writes Edmund Conway in 50 Economics Ideas You Really Need to Know ( www.landmarkonthenet.com). In the earliest days of financial investment, from the Renaissance in Italy to the seventeenth century, the main outlet for such cash was government bonds, but everything changed with the birth of the world's first corporations, he traces. “They ushered in a world of shares, of speculation, of millions made and millions lost and, of course, the earliest stock market crashes.”

For starters, as the book narrates, the first recognisable company was the Virginia Company, set up to finance trade with colonists in America, but the first major corporation was the British East India Company, which had a government-granted monopoly on trade with British territories in Asia. Three ways in which these first companies set themselves apart from their predecessors (guilds, partnerships, and state-run enterprises) were in the way they raised money, the right given to shareholders to sell their shares, and the limiting of liability.

“The new companies issued shares or, as they are more often known today, equities. Unlike bonds, these give the shareholder formal ownership of a share in the company and, as such, much greater influence over its destiny…”

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