"I believe that some of these multidisciplinary technological companies ... have recently proven some of the finest opportunities for truly farsighted investing. I am inclined to think that more such opportunities will occur in the future."
-- Philip A. Fisher, Conservative Investors Sleep Well
Most of the great investors whose writings occupy my bookshelf, such as Fisher, Warren Buffett, and Peter Lynch, have stressed the importance of seeking businesses with lasting competitive advantages. These advantages may take many forms, such as economies of scale, brand recognition, or monopoly power. Today we will examine one you rarely hear about: unique technological combinations.
As Fisher explained, a company that is first to combine a technology such as software with a discipline in which few competitors have expertise gains a sufficient competitive advantage that all but guarantees high profit margins:
... if, instead of just a technology based on electronic hardware and software, producing the product calls for these skills to be combined with some quite different ones ... the best-run innovators [secure] a far better opportunity to build themselves into the type of leadership position in their particular product line that carries with it the broad profit margin that tends to continue as long as managerial competence does not weaken.
Witness Medtronic's (NYSE: MDT) historic success in medical devices. When the company produced the first implantable pacemaker in 1960, why did larger electronics manufacturers, seeing the market potential, not rush in and produce similar devices? Putting aside the question of patent protection, I suspect that otherwise capable and more powerful electronics firms could not have competed effectively, because they did not immediately possess, nor could they easily acquire and integrate, the technical competence required to produce devices interacting with and residing in the human body.
Today, Medtronic's market cap is $41 billion, and other industry powerhouses such as Boston Scientific (NYSE: BSX) and St. Jude Medical (NYSE: STJ) are competing successfully to produce implantable electric medical devices. Thus we see that if the "lone ranger" advantage that Medtronic enjoyed 50 years ago has not completely disappeared, it has at least shrunk considerably.
Fisher died in 2004 at the age of 96. Is his advice still relevant today? If so, where should today's investors look to find such an advantage? One idea where attractive opportunities might exist is the software sector.
The past 30 years have seen the software sector come a long way, and it seems to me that the industry as a whole has plenty of room to grow. Software, in one form or another, is likely to affect our lives significantly more in the future than it does today.
One particular problem that the software industry presents to investors is the plethora of competing "code writers" offering similar "solutions." Maintaining a competitive advantage often proves to be quite challenging in this ever-changing industry. What we need is a software company that is clearly different from its competitors.
Kenexa (Nasdaq: KNXA) might be such a company. Similarly to Taleo (Nasdaq: TLEO), SuccessFactors (Nasdaq: SFSF), and Oracle (Nasdaq: ORCL), Kenexa offers a software-as-a-service (SaaS) solution to corporate HR departments which assists them in attracting, hiring, tracking, and analyzing employees.
Unlike other software vendors, however, Kenexa (of which I own shares) also boasts a worldwide employee survey business and designated research staff engaged in the study of employee behavior. Such services, when combined with the data-aggregating power of software, may allow organizations to see their workforces in ways never before possible.
The astute and inquisitive among you might wonder: What would prevent software competitors from developing a survey business?
A survey service is similar to premium chocolate. (Learn about my favorite chocolate factory stock). It can take years to perfect the technique and gain customers' trust. Companies want to know that their survey partner will craft questions effectively, and that analysis will produce results. Furthermore, companies spanning the globe may wish to deal with a provider that can address cultural and language differences. Such barriers may explain why I can find only a couple of major players in the employee survey market.
In this regard, Kenexa's closest competitor seems to be the niche service company The Gallup Organization. Interestingly, Kenexa's president and COO was a vice-president at Gallup in the early '90s. Another current executive vice-president at Kenexa spent 15 years at Gallup as a senior executive.
By themselves, neither the capabilities of software nor value-adding research and survey services is sufficient to set Kenexa apart. Instead, the unique combination of the two is not easily duplicated. It may create a hedge of sorts from competitive attacks if, as Fisher says, "managerial competence does not weaken."
What do you think? Is Kenexa the type of "multidisciplinary technological" company that Fisher referred to in his book? Can you think of other companies (perhaps in other industries) that fit this description? How competent is Kenexa's management? Let me know by leaving a comment below.
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