Posted by: donmihaihai | June 3, 2011

Business and competition

TPV is a wonderful learning experience for emerging exciting technologies/ products, declining products, scale and competition. My first purchase was made during the time where CRT was the standard monitor and newest exciting product was LCD monitor. Shifting from CRT to LCD was the trend and produced extraordinary growth of double to triple digits in LCD segment for TPV while CRT was declining slowly.

What not to like? Almost nothing as a simple count will produce positive points like,
1) New sexy high growth technology product = high growth, high profitability, premium stock price
2) Unstoppable trend toward outsourcing plus huge market share = Economics of scale = bargaining power with customers = high profitability.

Looking back, it was almost no brainer at that time that as long as I do not pay a high price and I almost got it right except one of the most important point — profitability. It has nothing much to do with downward shift in monitor price. If that is the case, many businesses will be out of businesses within a few years. That included Microsoft.

Technologies change does not resulted to higher profitability even if it has all kind of tail winds. For the past 10 years, TPV is supported by CRT follow by LCD monitor. Profitability of CRT looks better than LCD. Technologies and new products does not provide profitability, demand and supply produce short term exceptional profit and competitive advantage or competitive landscape produce long term profitability. And when technologies keep changing, I am always worried.

What will happen to TPV when LCD TV starts “talking” to all devices? I don’t know, even if TPV is still assembling TV, what will be the cost and selling price like? Facebook is like an exchange, a platform for other to ride on, and can it become something more than that? Very hard and despite being the hottest the website to be, will it continue to hold it 5 years down the road? I won’t bet any money on that. Google like CM said, is something more special, unlike every other website that I know, Google function like an smart toll who main job is to throw traffic out of it rather than hold on traffic as long as possible. If it keep continue, it may become the only toll in the internet world and user like me will be googled and becoming an illiterate literate.

Micro Mechanics keep saying that they are in a tough industry, facing constant price pressure and some of the directors commented that if they knew it earlier, they won’t do it. But this is the best music that I heard. In any industry, the worse thing is to have entrants constantly entering — the most important Force in Porter 5 forces. When the thread of entry is limited in an industry that constantly moving forward requiring smaller and smaller precision component, consumable or not, it will produce an industry that is favourable for incumbent firm.

Sarin Technologies is created by R&D and is easily recognisable that it has competitive advantage. Its competitive advantage is not created by R&D even though R&D is its main focus. It is because Sarin is the big fish in a small pond. A small pond is with few players and a dominant player is a good landscape for better profitability. And it is even better when entry is protected by technologies and reputation. While an entrant with new technologies can harm incumbents, a small industry usually don’t allow entrant to earn enough profit with a new product to establish a comprehensive range of products. What more, new entrant can’t just complete with price alone as reputation is equally important. Currently Sarin is not just building up a range of comprehensive products but by combining products into “stations” to create switching cost.

A Small industry created by technologies selling high price equipments where reputation is equally important, housed a few players of which one is a dominant player. Dominant player is trying to create switching cost. What not to like? Dominant player starts thinking that they are the kings of the industry.

There are not many companies like Sarin Technologies, Micro Mechanics or even TPV. It is not just about having good profitability for a period of time and competitive advantage for Sarin is not unbreakable. Anyway it is still a work-in-progress for Sarin. For many companies, some kind of advantage is created because the industry matured and incumbent firms does not doing anything destructive or has the distribution reach. Some companies generated better profitability in a competitive industry by not joining the crowd.

Talk about OSV industry or even further upstream like contractors and E&P. As one operate further upstream, profit earned will be more and more like an E&P and what determine profitability for E&P is other than lady luck, profitability is ultimately depend on cost and oil price. But the interest here is more on vessel and rig operators and builders.

Think about this, when a company announced that they are contracting to build or to owned vessel cater to a favourable segment of lets say deep water. And let say that segment is the segment to be with favourable demand. What does that mean? Nothing much except that the segment is hot and possibility of higher profit for a short period.

Why? Think about it in this way.

Does that company owned the design? No.
Can any other company owned the same type or even better vessel? Yes.
Is that segment favourable and known by other? Yes and YES.
Is vessel builder earnings good profitability and know about it? Yes and yes
Even if current profitability is going down, is it still better than building other type of vessel serving other industries? Yes.
How hard it is for a bulk ship builder to start building high spec OSV? Very hard. But all it needs to take is just to entry into the segment and every company is moving a step upward.

So where is the competitive advantage? Long term chartering contact? Since it is a contract entered by two parties, benefit is either share by them or one will gain while the other will take the hit. Think about what will happen if the company entered into an unfavourable contract that goes on for 5 to 10 years. Stop. I know someone will say management is smart enough not to do it. Then may I ask, is the other party stupid enough?

Lastly, I said barrier to entry is the most important of the 5 forces. Why? Because as long as they complete base on price alone or partly on price, any big fish will look around for ikan bilis. It does not required ikan bilis to become big enough for pricing pressure. Think about moving up the ladder in term of pricing in the industry. And when barrier of entry is high enough, it created space for incumbents to mature and pull themselves away from new entrant.

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Responses

  1. Hi,

    if the barrier on entry is high, but the companies compete based on solely on price, then the business does not make good sense, as they will cut price to gain or manitain market shares (e.g manufacturing of commercial aircraft).

    If the barrier of entry is high, esp due to high fix cost and capex (maybe like Tat Hong..), and the companies compete based on price only (I am not sure for Tat Hong case) – when there is an excess capacity or a turn of demand, the companies will have to cut price to maintain utilisation to survive and it is difficult for them to exit the market.

    I consider product differentiation and pricing power (of some sort) is key to business success, like Sarin that you owned: unique product, and they are making it a necessity for their consumers. High barrier of entry and high concentration are always better…but may not be guranteed good busines. Just my comments…

    maniac

  2. Is manufacturing of commercial aircraft a lousy business? I don’t know but I will bet otherwise.

    Is high capex a form of barrier of entry? Unlikely and if it is so, it will be the worse form of barrier of entry. What is the cost of a new crane? New vessel? New building? Does that stop new entrant? No.

    I think product differentiation is overrated. The place it might work is likely to be consumer product. Look at iphone and ipad, unique product, cool and product differentiation. Does it stop other from coming in? No. Anyone talking about ipod anymore? Profitability of ipod in 2010 vs 2002? I don’t know but it can’t be too good.

    Pricing power – hard to explain but it is about mindshare, about die die must buy that product and pay for it. Look at STI stock — CapMallsAsia, CapitaLand, CapitaMall, CityDev, ComfortDelGro……… Wilmar. How many of them has pricing power? Hmmmmm……… And are they successful? Why not.

    Sarin might be producing some unique products but Sarin is just fulfilling a need in the industry. Yes there is reputation but if there are lot of competiting products around, I will bet that pricing will become an issue. The key is why it isn’t such a case? Before 2000, a new entrant with one or two products can enter this industry, now it is talking about a range of products. Another 5 to 10 years, an new entrant might need a “work station” to compete. This is the type of barrier of entry I like.

  3. Have you read “The Little Book that builds Wealth” by Pat Dorsey (of Morningstar)? The whole book is about identifying common barriers to entry. One of the best and easiest-to-read books I have come across. You can get it from the library.

    I’m interested to see how Sarin is trying to create switching costs. Hopefully I get time next weekend…..


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