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What are the types of competition in business? Why are conservative companies reluctant to invest in hot new technologies?
In Poor Charlie’s Alamanack, Charlie Munger identifies both competition between rivals and creative destruction through technology as the two primary types of competition in business. Competition between rivals can be friendly or fierce, while competition caused by new technology can either level the playing field or give a company a decisive advantage. This is why Berkshire Hathaway is reluctant to invest in hot new technologies. New technologies are not always easy to understand and the company’s operators prefer to invest in businesses they understand deeply.
Read on to understand more about the types of competition in business.
Types of Competition in Business
Munger identifies the two types of competition in business as competition between rivals, and creative destruction through technology.
Competition Between Rivals
Of the two types of competition in business, competition between rivals has an interesting phenomenon where some industries see a healthy level of profits amid reasonably friendly competitors, while others see fierce pricing battles and evaporated profits.
An example of the latter is the airline industry, which has been perennially unprofitable. Because airline seats are mostly seen as a commodity by customers, competition operates on the basis of pricing, which drives competition progressively toward lower and lower pricing, which in turn erases profits.
In contrast, Munger points to the cereal industry as surprisingly healthy. Despite the presence of major players like Kellogg’s and General Mills, as well as generic supermarket brands, it appears that companies can still healthily exist and earn profits. Munger explains this in a few ways:
- Cereals aren’t a pure commodity—people are willing to pay higher prices for certain brands, which allows the more recognizable brands to command higher prices and earn more profits.
- There might also be less intense rivalry for market share. If a certain player wanted to dominate in market share at all costs, it could lower prices and evaporate its own profits. In turn, other players would be forced to follow suit, and the entire industry’s profits would collapse. That this doesn’t happen in certain industries likely means the players are playing nice with each other and implicitly agreeing not to destroy the market in this way.
Munger notes that while insurance may seem like a commodity business, it’s not completely—people buying insurance have to evaluate the longevity of the insurer and the likelihood that it’ll pay out when it’s expected to.
Creative Destruction through Technology
Creative destruction through technology is the most unpredictable of two types of competition in business because technology evolves so quickly that a new technology can make an entire industry obsolete within years. In the early 20th century, there were entire industries built around horses—saddlemakers, ferriers, and so on—that were wiped out when the automobile came along. Businesses are often unable to control the development of such technologies, and so they need to adapt to the new technology or risk being destroyed.
At times, technology won’t be a risk to a company but rather improve its operations. However, this type of facilitating technology doesn’t automatically mean it improves the company’s profits. New technology that becomes accessible to everyone is quickly adopted and becomes table stakes; no company has a meaningful edge over the other, and all the value gets passed down to the customers. In contrast, if you own a proprietary technology that no one else has, you can develop a meaningful moat.
When you see a new technology, evaluate whether it’s going to help you or kill you.
Buffett and Munger are well aware of the greater danger of creative destruction among the two types of competition in business and that probably explains why Berkshire Hathaway is famously allergic to investing in hot new technologies like software or pharmaceuticals, instead preferring to invest in businesses they understand deeply. Said Buffett about the Internet: “Change, as in the case of the Internet, can be the friend of society. But it is the absence of change that is often the friend of the investor. While the Internet will change many things, it will not likely change the brand of gum people chew. Charlie and I like stable businesses like chewing gum and try to leave life’s more unpredictable things to someone else.”
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