Warren Buffett likes to hold Coca-Cola as a shining example of a business that is excellent because of its competitive standing.
He once said that "If you gave me $100 billion and said take away the soft-drink leadership of Coca-Cola in the world, I'd give it back to you and say it can't be done."
I tend to think great investments are identified by finding business models that would be impossible to ruin with competition. Many businesses have one or two abilities that make them better than their peers. For Coke, it's the two-pronged power of branding and distribution.
For American Express (NYSE: AXP), it's the ability to charge above-average transaction fees and generate more transaction volume per card. American Express customers spend more per card, and the company prices its network so that it is always more expensive than Visa's (NYSE: V) and MasterCard's (NYSE: MA).
How do you kill American Express?
If American Express' strength is its pricing power and transaction volume per card, its potential weakness is losing what gives it these abilities. In the words of Charlie Munger, "invert, always invert."
I submit Amex's lofty spending per card and higher-than-average fees is the result of its dominance in corporate cards.
Corporate cards are perhaps the very best kind, as they generate more spending, default less frequently, and often have no competition at the time of purchase. (Your average employee certainly isn't carrying around four corporate credit cards on four different networks.)
A recent brief from the Department of Justice also reveals that:
- American Express captured 64.3% of corporate credit card spending in the first half of 2013.
- Around 70% of its corporate card customers have a mandation policy, which requires that employees use their Amex card for business expenses.
- Many companies simply have no choice but to pay American Express's higher fees. Hilton noted that it would likely lose about two-thirds of its current Amex charge volume if it no longer accepted American Express, due to the significance of corporate travel customers. Other hoteliers responded similarly.
Thus, for many companies, it is much better to accept American Express and pay higher fees on corporate and personal Amex charges than it is to reject Amex and lose corporate customers who have no other payment option.
If there were any single issue that would worry me as an American Express investor, it isn't the company's co-brand deals with the likes of Costco or Fidelity. These are really commodity deals, subject to competition at every renewal. Its clear from Visa and MasterCard's filings that co-brand deals are becoming more competitive. American Express also cites it as a potential risk in its financial filings. If any issuer or network wants to win a co-brand deal, it can do so at the cost of lost profitability.
Instead, you kill American Express and permanently impair its moat by winning over its corporate customers. If you do that, you take out the most important cog in the wheel of its above-average pricing power and transaction volume per card.