More Notes about Moats

How about your Moat? And why am I still talking about them?

The concept of the Moat may be an old and worn one to the financial/investment community, but it is a fairly new one for me. So my infatuation with the concept continues because it is an excellent way to merge the tangible and intangible elements of business success. More, it focuses all business efforts on one goal: sustainable value creation-value being the difference between risk and reward.

That being said, I have always faulted the investment community for not considering the real boots-on-the-ground factors in a company’s performance and potential. The moat concept partially fills that need, but I think the investment gurus are not qualified to drill deeper into what really distinguishes and protects a company in today’s market.

A key criterion for all moat-evaluation is “barriers to entry.” In the world of apparel and retail, this may be just a little stupid. Really. Anyone with a good concept, good product and good execution, especially in today’s ultra-connected world, may waltz into a product space and disrupt it, compete in it, dominate it before we get our next coffee. This has always been the case; the difference today is the lightning speed at which it can happen enabled by technology.

I know I have championed evolution as the founding principle of change in the retail industry, but within the evolution there is the moment of emergence, blast-their-ass if you will, where a company emerges from oblivion to get the attention of many. Everlane, Tommy John, Untuckit, Bonobos, more. In most cases, these entrepreneurial heroes have been working for years with no satisfaction, then it frkn happens…

So they cross the moat and invade the castle of the established companies, how? By being cheaper? This has never been a weapon for new entrants. It is only the weapon of the old combatants who have stale cultures, which discourage entrepreneurship.  For the newbies, it is about being more interesting, more exciting, more desirable, while maintaining VALUE perception. Disruption crumbles walls.

So how do we really judge a moat? The investment world has metrics to assess the wideness or even existence of a moat. Because, as an informed investor, I need to know not only what is in the moat, but what is inside the castle. What are the elves doing to create and maintain sustainable value?  

Morningstar’s report, “Wide Moat Investing” (https://www.cfasociety.org/cleveland/Lists/Events%20Calendar/Attachments/979/Wide%20Moat%20Investing%20-%20CFA%20cleveland%20May%202016.pdf) defines its moat rating (Wide, Narrow, None) in terms of “Sustainable competitive advantages that allow a company to generate positive economic profits for the benefit of its owners for an extended period of time. “ Key word-Sustainable. Price by itself is not a sustainable advantage.

The report further breaks down the five sources of economic moats:

1.     Intangible Assets

2.     Switching Costs

3.     Network Effect

4.     Cost Advantage

5.     Efficient Scale

Note only one of the above, Intangible Assets, relates to the most important elements of success and market penetration (Moat-busting) today- product, position, value perception, and shopping experience. What the elves are doing inside the castle.  The report gives examples of Wide, Narrow and No Moat companies with a brief explanation:

1.     Wide- Coca Cola- “It’s just sugar water, but consumers pay a premium.”

2.     Narrow- Adidas- “Has strong and recognized brand in athletic footwear.” (This is why we need to look beyond finance reports for the real answer. Brands are BS in today’s market; a brand is the poorest barrier to entry and the fatal flaw of those who hold on to it as a moat-widener or even moat-element)

3.     None- United Continental- “Name recognition doesn’t result in sufficient pricing power.” This explanation applies more to Adidas, and vice versa for Adidas’ explanation.

I note that the report chooses Macy’s as the No Moat example under switching costs: “Consumers easily pick and choose among many retailers.” What I said—Price does not help your moat. And, if you depend on it, as Macy’s has been, you are filling in your own moat.

An important aspect of Moat Evaluation in the report is the “Moat Trend.” As Warren Buffett said,  over time the moat is getting wider and narrower constantly, as business competitive situations are typically dynamic. Moat fluctuations are rated as Positive, Negative or Stable. Let’s pick some examples that would be familiar to us:

1.     Wide Moat-Negative- Walmart. “Shift to e-commerce will likely take share and make large Walmart stores less productive at the margin.” Yes. Even if Walmart expands its e-commerce business as it is trying desperately to do, it will be cannibalizing big chunks of its retail space, reducing sales/sq. ft. and revenue/employee. (NOTE: Next article up will evaluate Walmart and Target’s prospects-news at eleven).

2.     Narrow Moat-Stable-Ross Stores. “Competition likely to increase, but continued growing scale at Ross should offset major threats.” Maybe, but this is more true of TJX than Ross.

3.     No Moat- Positive-Not given in the report, but I might elect Target as my candidate here.

So, if you are paying attention here, and believe in the concept of the Moat, no matter who you are in the fashion/retail industry, you need to keep in mind two realities to keep your Moat afloat and create sustainable value over time:

1.    Any day a little startup ant of a company can turn your castle into a wasteland before you can say stock options.

2.    Your best defense is a good offense. Make sure the elves are working on the vision of a future with sustainable value creation. Not price, not community events or symposia (not that there is anything wrong with that), but real, bold, disruptive results in every area from design to merchandising to production to retail-every day in every way.

Folks, economic data that define the success of a company for its shareholders are the RESULT of these decisions. And what the elves are doing.

What's in YOUR Economic Moat?

I hope, a lot of crocodiles and piranhas (That’s a good thing, read on please).

I learned something recently. Researching exactly how the financial world had evaluated the winners and losers in today’s world of business (especially retail), I learned about the moat.

Following all the financial analytics, I came to wonder what the investment community looked at that told them what was behind the numbers.  It seems that all things product, marketing, supply chain, etc. are captured in the concept of the moat.

What is a moat? It is a body of water that traditionally protects a castle from invaders. Are you starting to see it now? We can see any business as a castle, with a moat around it. How effective the moat is determines in protecting the castle, both short- and long-term, its vulnerability to competitors and barriers to entry of its market share. Warren Buffett first coined this term and explains:

What we refer to as a “moat” is what other people might call competitive advantage . . . It’s something that differentiates the company from its nearest competitors – either in service or low cost or taste or some other perceived virtue that the product possesses in the mind of the consumer versus the next best

alternative . . . There are various kinds of moats. All economic moats are either widening or narrowing –even though you can’t see it. (Credit Suisse, “Measuring the Moat,” 2013)

To the investment world, the bottom line of Invest or No Invest is a firm’s ability for value creation-SUSTAINABLE value creation. So whatever the analytics tell you, the most important thing to take into consideration is the moat-what is the firm’s ability to withstand and stay a step ahead of its competitors? How easy will it be to take a piece of the firm’s business either by competing on price or product? How vulnerable is the firm to disruptive innovation?

So let’s take an example of an investor’s losses due to miscalculating or ignoring the moat.  Daniel Schonberger writes in Seeking Alpha on December 7^th, “Lessons From 2017: Bed Bath And Beyond - The Worst Investment,” explaining why his investment declined about 50%:

• The first mistake was focusing too much on revenue and earnings per share and paying less attention to the different profit margins.
• The second important number, I didn't really consider, were the declining comparable sales.
• The extremely bearish sentiment is a third point I ignored a bit.
• And a last and fourth point that should have played a bigger role in the analysis is the missing moat of Bed, Bath and Beyond.

OK, he really blew it, but note that he admitted that the moat should have played a “bigger” role. Damn right-The castle can be bright and shiny one day and rubble the next. The barriers to entry that define that housewares industry have fallen-to Amazon. Think about it-shower curtains, towels, sheets, rugs, etc. Any need to trek to BBBY today? What is different and better about their product that you shouldn’t buy on Amazon? Is the only reason to buy on Amazon price? No.

Could BBBY have done more than they did about it? I will always answer this question with a YES. As a consumer, I could see that BBBY went nuts with all form of coupon and discount-so after a while the only reason to go there was the challenge of how to manipulate the dozens of coupons you had to achieve the maximum savings.

Remember we said “sustainable value creation.” Price ain’t the way. Maybe BBBY could have made efforts to distinguish its product from Amazon, increased online penetration, or both. Or maybe not. In this case, the barriers to entry became pretty much zero for Amazon.

How will incumbents typically respond to disruptive innovation? Credit Suisse reports on a study by Christensen, who is famous for studying disruption, that

“For low-end disruptions, the motivation of incumbents is generally to flee…In the short run, fleeing helps profit margins by encouraging the incumbent to focus on the most lucrative segment of the market. In the long run, it provides resources for the disruptor to build capabilities that allow it to penetrate the mainstream market on a cost-effective basis.” (English- run away from your disruptors by focusing on your mainstream, most profitable, business, thus opening the door for the disruptors to do something new and great without interference)

Or,

“Incumbents are typically content to ignore new-market disruptions.”  (This is my “living in a bubble of denial.”)

So the choice of flee or ignore is based on whether the disruption is a better way to do things (such as Tommy John, Zara or Uniqlo) or a totally new idea (such as the bralette).

This is really the sum total of all I have been saying for more than the last 8 months, but translated into the simplest concept of why companies will or won’t survive-their moat. I believe that a. in all cases they could have seen the invasion coming and b. their bubble gave them no inspiration to be disruptive themselves, whether for protection or not.

One of my favorite walk-of-shame stories, L Brands, whose key unit, Victoria’s Secret, has not only lost their way and their mojo, but has thrown away their moat by walking away from the most important concept to arise in years-the bralette (see my earlier article, “Bra or Bralette,” http://www.isourcerer.com/2017/08/bra-or-bralette-know-your-dinosaurs.html) and capped off by their undifferentiated  and price-oriented approach to Black Friday (see my article, “Living in a Bubble of Denial” http://www.isourcerer.com/2017/11/living-in-bubble-of-denial.html

Yet, Morningstar, after documenting the really poor performance of the company highlighted by the decline of Victoria’s Secret, (http://news.morningstar.com/articlenet/article.aspx?id=795357), said:

We continue to think that L Brands has a wide economic moat with brand strength in a category characterized by high levels of consumer brand loyalty and prioritization of quality and fit over price. That said, we have been and remain concerned about execution strategies, specifically promotions and store growth plans.” (What I said-read my articles)

I disagree- they gave up the moat by paying more attention to their fashion show (and spending who knows how much) than what their consumer was doing at their competitors-namely, buying bralettes- and figured, arrogantly, that their brand was enough to get their customers to ignore a trend that put money in their pockets (lower cost of bralette, fashion right).

Folks, brand loyalty is BS in today’s market. With so many new brands popping up every day, whether on Amazon or by themselves, consumers have NO REMORSE about switching to Brand X if a. the price is lower, b. the styling is more innovative, c. the in-store or online experience is better and easier. Especially in the case of Victoria’s Secret, as bras and underwear are repeat items, the enemy at the gates is-or should be-a constant concern. Not ignored or fled from.

So how is your moat? This is a mission-critical way to think about your business. IN considering your moat and your vulnerability to invasion and annihilation, here are a few items to think about:

You are in the business of adding sustainable value (oh, I also talked about that,  repeatedly, in this blog).

So what are the  sources of added value?

1.     productive advantages

2.     Consumer advantages

3.     External factors

(You should have already evaluated all three tirelessly, and renew your assessment daily.)

Your moat is a barrier to entry. What are the barriers to entry for your business model? Better, Cheaper, Faster- this protects you.

What distinguishes your product from your competitors does NOT have to be anything as dry as price, fabric, or crotch length. NYU Stern’s Scott Galloway, in his new book, “The Four: The Hidden DNA of Amazon, Apple, Facebook and Google” talks extensively about ladders and moats, and gives the example of Apple’s “romance, connection and general awesomeness”:

 So, Apple, recognizing that ladders will keep getting taller, opted for more analog (time/ capital expensive) moats. Google and Samsung are both coming for Apple. But they are more likely to produce a better phone than to replicate the romance, connection, and general awesomeness of Apple's stores. So, every successful firm in the digital age needs to ask: In addition to big, tall walls, where can I build deep moats? That is, old-economy barriers that are expensive and take a long time to dredge (and for competitors to cross). Apple has done this superbly, continually investing in the world's best brand, and in stores. 

Where can I build deep moats? Do you ask yourself that question every day? Do you know what is your moat and how vulnerable it is? Are you ready to take the attitude of not only building deep moats (defenses with a crystal clear picture of your competitors AND where you are vulnerable, no matter what your company name or your brand) but also of building “big, tall walls? (offense-product differentiation, innovation, awesomeness, romance, etc.)?

(BTW, this requires you to leave arrogance and attitude at the door.)

You better be ready, and willing to change anything and everything that needs to be changed to be a sustainable value creator. OR, you will cease to be a destination for investors OR customers.

So, what is your story? Tell me about your walls and your moat.

Living in a bubble of denial OR why I am still jobless?

Being jobless for these months has taught me a lot.

(Which proves that, everyday of our lives and no matter at what age or stage, we can learn more than we could possibly imagine.)

When I first came back to the US after 10 years in China, and started this blog, it was to establish my “brand.” But as I began to learn more and more about the world of apparel and retail today (possible employers), I found that there was a clear message coming to me: The companies I had held in my mind as icons had, for the most part, lost their way, their identity and their customer.

Then, upon talking to many of them about possible employment, I found that they had no clue about the fix they were in. They were narrow-minded and sometimes (usually) arrogant. Rather than look for someone with the experience, talent and character to raise them up, it was business as usual. Here’s a particularly ridiculous example: After more than 30 successful years in global sourcing and retailing, Macy’s told me that a position whose title was “Sourcing Strategy” was not for me.

So here I am and here we are. My last article was about the “Category Killers,” a term I coined to refer to the companies that were reshaping retail by their laser focus on customer and product (in that order). Now we see the killed or to-be-killed. Various companies, various products, but they all have one thing in common: they are living in a bubble of denial.

It is an easy disease to catch when you are working in a self-reinforcing environment which makes you feel how great you are just by showing up to work, not by what you accomplished to make the world or your company better and more secure every day.

Let’s nominate some companies to start this “walk of shame.”

1. L Brands/Victoria’s Secret

Victoria’s Secret. Billions spent on a world-renowned fashion show with world-renowned models. So cool. Despite that, the customer is leaving. Look at this, money talks:

This one through August 17. If I could find a newer one, the bottom of the chart would probably need to be expanded. (Note L Brands includes other companies such as Bath and Body Works, whose troubles are attributed to the stores being mall-based—yo, the decline of shopping malls is not new news, what are you doing about it? Tell Wall Street, since you sure won’t tell me-looks like same bubble of denial).

Wait, I love this excuse- Victoria’s Secret sales declines are attributed to their exit from the swim and apparel categories. (marketwatch: https://www.marketwatch.com/story/l-brands-problems-extend-beyond-victorias-secret-bras-to-bath-body-works-2017-08-31).

So you are going to focus your future on what you do best-bras?

That business also is evolving away from Victoria’s Secret, by their own hand. In my article, “Bra or Bralette?” I documented my prediction and reasoning why I thought the bralette would eventually replace the structured bra. This should be a good business for Victoria’s Secret, right? No. They also walked away from this business.

To quote myself in the aforementioned article, “But more than that, I am predicting the marginalization, if not extinction, of those who miss the signals of disruptive change, or see them and stand pat. I know a dinosaur when I see one.”

I know a bubble of denial when I see one.

Here are some pictures from one of Victoria’s Secret’s stores’ Christmas windows (what do you see that they have in common? I see the word FREE):

2. J. Crew-

After announcing that they would be closing 50 stores instead of 20:

Talk about denial- First, we hear that J. Crew’s problems are due to the fact that clothes are going out of style. From the chairman and Legend Mickey Drexler:

Clothes are just not that important or as important as they were,” he said during during a conversation at The New York Times DealBook Conference. That, and we all seem to be glued to our phones. “[People are] not really hanging around in shopping centers," he added. "[Cell phones] are local villages, and you don’t have to go to the villages to see people.”

Then the new President Mike Nicholson claims that stores are going out of style:

 “In order to drive top-line growth, we must evolve our business model from a traditional brick-and-mortar specialty retailer to a digital-first omnichannel business,” (last 2 quotes: http://www.refinery29.com/2017/11/182285/jcrew-store-closings-2017)

Tell that to Inditex. And H&M. And Lidl. It is refreshing that, at least, neither is blaming it on Amazon.

OK, you tell me: Bubble or no bubble?

So, back to my joblessness. If you go to Glassdoor, J. Crew has more than 100 jobs posted in the NY area. Even if I could get one of those jobs (and I probably couldn’t because I am not a narrow fit for the positions or some other unknown reason), I couldn’t do it. After all this, I can’t live in a bubble of denial.

Which is why, unless one of the Category Killers or a spanking new and exciting startup is willing to hire me, I will be seeking employment outside of the apparel industry, where I have succeeded for more than 30 years. What a waste….

I want to go home every day believing I did some good work for my customer, my company and the world of business. If I can’t, then something is wrong with where I am working, because in a company bound for success every employee, top to bottom, should feel that way every day.

Fortuna Iuvat Fortes.