Friday, May 11, 2012

Tom Russo: First Mover Advantage and the "Capacity to Suffer"

From an interview with Tom Russo in the latest Graham & Doddsville newsletter:

"The three prongs that I look for when investing in a business are: the fifty cent dollar bill, the capacity to reinvest in great brands and the 'capacity to suffer.' The 'capacity to suffer' is key because often the initial spending to build on these great brands in new markets has no initial return."

It's not hard to see why first-mover advantage is so valuable. If a brand becomes firmly established in the minds of consumers in a new market ahead of competitors, it is more likely to have sustainable higher margins and returns. Russo later added the following:

"...invest a lot of money upfront to build your store presence, distribution, advertising, etc. Then you become a first mover and your brands become identified with a particular product category."

The problem is that to gain this type of advantage, it warrants patience and the acceptance of what seem like unattractive returns in the early stages while the brand and distribution are being built.

Sometimes, a substantial business expansion opportunity (think along the lines of a move into a key new market like China or India) demands a willingness to invest persistently over a sustained period where explicit returns may not be obvious for some time.

Companies like* Coca-Cola (KO) or Diageo (DEO), at least if management is doing its job well, are making long-term investments in new markets now but the returns from these efforts are not yet visible.

If their efforts are being well-executed, that lack of early stage returns is likely a good sign. Why? Focus on showing a profit too soon and the advantage may be lost.

Weak upfront investment opens the door to competition that can make the long-term economics less attractive.

It's best to enter a new market forcefully (and for an extended period) so a brand gets favorably entrenched earlier than the rest. This makes it difficult for competitors to drive down future margins and erode long-term returns.

If efforts to move into a market are well-executed, and what Russo calls the "capacity to suffer" exists, it can end up paying off for the long-term investor in a meaningful way.

Just expect it to do so on a substantial lag. It helps if management and the owners are on the same page so the necessary patience is there.

The bottom line: The push for profits too soon probably lowers long-term returns.

For an investor the tough part can figuring out who is actually doing this kind of thing well.


Established long positions in KO and DEO at much lower prices. Great businesses but these aren't bargains near current market prices.

* The examples Russo uses in the interview are Nestle (NSRGY), Unilever (UL), and Heineken (HINKY).
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