Monday, November 16, 2009

Kraft and Cadbury

Here is a good article on economic moats.

First, it references a quote from this column in The Economist on the Kraft-Cadbury deal.

Chocolate companies as a breed also have a peculiarly intimate relationship with their customers, partly because chocolate is involved in so many childhood, romantic and festive rituals, and partly because people acquire their tastes in chocolate at their mothers’ knees. Most Britons would rather eat scorpions than Hershey bars. - The Economist

And here are some excerpts from the article itself.

This illustrates how powerful and valuable brands can be. Many parts of the world are currently unfamiliar with chocolate and are "blank slates" in terms of forming brand awareness. As The Economist article points out, the first mover in those countries is likely to build brand loyalty that will be difficult or impossible to displace. Furthermore, since chocolate is a low priced luxury item, the millions of upwardly mobile consumers in developing countries will find it increasingly easy to afford the product.

...Kraft management obviously believes that Cadbury's existing distribution system in places like India will create a powerful economic moat and end up justifying the valuation.

Recently, I posted this on the power of consumer franchises.

...an established consumer franchise with pricing power (and, as a result, superior returns on capital) can use the extra cash coming in to build stronger distribution and buy more advertising. Over time that stronger distribution and bigger ad budget reinforces the strength the of the brand(s) and widens the moat. It's more generic competition with lower margins can't afford to invest as many $'s in product, distribution, and advertising so over time the gap tends to widen. The interplay of these forces makes most of the larger consumer franchises nearly impossible to displace.

As an investment model, looking for businesses with the above characteristics that are selling at reasonable prices is not a bad place to start.

Adam

Long position in KFT

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