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May 10, 2000
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Why a Fool loves a Monopoly
I have a confession to make: I love monopolies. My portfolio is lousy with them. I have pharms that monopolize the sale of certain drugs--with the government's backing, I might add. I have software companies with market share in certain market segments that comes close to Microsoft's share of PC OSes. I have food companies with such strong brand names and supply muscle that they take over 70% or more of a supermarket section (you ever try to find potato chips that are not made by Frito-Lay?). In fact, if I didn't think the DOJ had such a strong case, I would buy me some MSFT now. Give me a boatload of monopolies and I wouldn't have to drag myself through another 10Q again. I'd be on down-town Eee-zeee Street.
A Fool loves a monopoly too. In fact, I would say it was the way TMF explained how to translate the intangible concept of monopoly power into real numbers and tangible attributes that attracted me to this web site in the first place. Monopolies are the only game in town. You are either currently a monopoly, or you are trying to build a monopoly. Rule Makers are current monopolies; Rule Breakers are monopolies in training. Everyone else is simply a lousy investment.
Let me run through some of the major Rule Maker and Rule Breaker principles and make a brief connection with the concept of monopoly power.
--Dominant brand A brand is a form of monopoly. Coca-Cola has a monopoly on "Coca-Colas". Until recently, they also argued they had a monopoly on "Colas." Trademark protection is one of the legal monopolies in this country.
--Gross margins at least 50% High margins are the hallmark of monopoly power. When no one else is making Claritin (made by one of my companies), you can charge high prices. Competition drives down prices, drives down margins. I leave it at that; it's ABC economics.
--Net profit margins of 7% or greater Ditto on the high margins.
--Flow Ratio below 1.25 A flow ratio is essentially the ratio between what you owe others and what others owe you . If you can get others to pay you on time while making them wait for you past the bill's due date, that's an indication of monopoly power over your customers or your suppliers.
--Top dog and first-mover in an emerging, important industry The ultimate top dog is a pure monopoly. The point of being first mover is to lead the race in establishing the monopoly for the industry.
--Sustainable advantage, gained through business momentum, patents, visionary leadership, or incompetent competitors. Sustainable advantage is the vaunted Buffett "economic moat." It means other competitors can't get at you, which is the method for establishing a monopoly. Patents are another form of a government-sponsored monopoly.
--The greater the consumer brand, the better. Once again, ditto brands and trademarks.
--A recent constituent of the financial media has recently called the company "grossly overvalued." Overvaluation by common standards is another hallmark of a monopoly. Common valuation standards are devised for run-of-the-mill companies with average competitive power. Overvaluation is reserved for companies with monopoly power.
Now don't get the impression that I am attacking TMF. Everything I know about investing, I learned from the Gardner brothers and their excellent staff, and I use their monopoly-building criteria every day when evaluating investment opportunities. For example, I am currently evaluating Palm Inc., and the biggest question--the only question--is how well they will be able to build a sustainable monopoly in handhelds, where Microsoft is the least of their competitors (I'm far more concerned with the cell phone and pager makers, like Nokia and Motorola, and the Linux-based machine Samsung is working on). I sincerely love monopolies, and apparently, so does the government. Patents, trademarks, copyrights, and all those law-related thingamajigs that Rob Landley just did an outstanding job describing last week (Rule Maker Report 05/05/00) are all legal monopolies protected by the Constitution in the name of fostering economic growth. The anti-Softies have made the point all along that monopolies are legal in this country, and the DoJ proposal leaves the various Microsoft monopolies intact.
So if me and the Fool love monopolies so much, where do I part company with the hard-core Microsoft-style monopolist? We have a tradition in this country, exemplified by Thomas Jefferson, that says every generation of Americans should start over. Everyone should be a self-made person. Jefferson did not believe in inheritance (apparently, neither do Buffett or Gates), and he thought that we should have an American Revolution of sorts every 19 years. Monopolies are the natural endgame of capitalism. It is unreasonable to think a competitive balance can exist forever and in all markets. After all, people win wars, people win basketball games, and it is reasonable to think people will also win markets. Jefferson was no opposed to winners; he was opposed to taking the winnings of one generation to dominate the next. This is the principle of hereditary rule: Because my family kicked butt in the past, I have the right to be king in the present. Monopolies are like hereditary rule. Companies that win markets in free and fair competition in the past establish monopolies. For the sake of argument, I'll plea nolo contendere (as if there wasn't enough legal mumbo-jumbo on this board) on the question of whether Microsoft won its monopoly in free and fair competition, but what I do have to ask is what their victory entitles them to under the American system. Patents, trademarks, and copyrights all have sundown clauses. Sundowns express Jefferson's belief that past advantages should not default into the future. The question is whether we have reached Microsoft's sundown.
I do not believe we have reached the end of the Microsoft generation yet. They have had their monopoly run for less than 19 years, and the argument can be made that they have not wrung their just deserts out of it yet. If they decide to milk the Windows monopoly for another 10 years, I don't think we should have a problem with that. Microsoft's transgression is not in trying to extend its monopoly in time; they erred in trying to extend their monopoly in space. By trying to leverage their Windows monopoly into different markets, such as applications, the internet, and handhelds, Microsoft tried to extend its hereditary rule sideways. They used their legal Windows monopoly to extend itself in the present across more markets than they had won through free competition. In doing so, they ran afoul US anti-trust legislation, which holds legal monopolies to a higher standard of conduct, and they ran afoul the tradition of Jeffersonian America, which suggests that they should compete anew on level ground in every market they choose to enter. They should have to compete just like the "heirs" of Warren Buffett will have to be ground-zero entrepreneurs down in the ditches with everyone else.
I admit I have a visceral revulsion for Microsoft, especially its brutal-minded leadership, but I honestly don't have anything against the employees and investors. I'm an investor myself, and the goal of investors and entrepreneurs is to build as unassailable a monopoly as possible. When the government stands in the way of that goal, it feels galling, but I think we have to understand that the government has responsibilities beyond what an investor and entrepreneurs feels. Monopolies are the natural endgame of competitive capitalism; when monopolies occur, competition dies and markets stagnate. This was the insight of Jefferson and the founding fathers: tyranny is the natural endgame of competitive democracy; when tyranny occurs, democracy dies and an entire people stagnate. That is the reason the government holds periodic elections and polices other checks against the establishment of hereditary power. Right now, Microsoft is feeling the effects of our government's anti-tyranny bias. For the sake of our polity, I think it is right and proper, and totally consonant with the best in the American traditions of free enterprise, that our government demands Microsoft lives up to the responsibilities of its monopoly privileges. Enjoy your monopoly now and enrich yourself, but do not demand that you be allowed to leverage it wherever you please.
So ask me again whether I still love a monopoly, and whether I would buy MSFT if I didn't think the DoJ had such a strong case? You betcha! Down-town Eee-zeee Street here I come!
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