Wonderful Company Series — Business Model Attributes
“It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." – Warren Buffett
If we agree with Buffett's above wisdom (often a best practice!), then the question naturally emerges – what constitutes a wonderful company? Our Wonderful Company blog series will outline North Beach Holdings' definition of a wonderful company and provide insight into our public company qualitative research process.
In our opinion, wonderful companies have the following business model attributes.
High recurring revenue
Low-quality competition
Low customer concentration
High customer integration
Low-cost proposition
High Recurring Revenue
More than simply repeat sales, recurring revenue is an essential component of our business model attribute checklist. This revenue type is relatively stable and certain, and high recurring revenue streams can reflect a strong business. In the public company sphere, we often see this when customers buy a product or service through a subscription or contract. See Dillon's post here for a more in-depth explanation of different types of recurring revenue and its presence in our private company process.
Low-Quality Competition
Wonderful companies must either be monopolies (not likely) or distinguished from their competition (more likely). Companies with low-quality competition are the industry standard and have the power to differentiate their products and services and, ultimately, set prices. Collectors Universe is a business that has low-quality competition. Its professional coin grading service is the basis for almost the entire coin collecting market, and their Professional Sports Authenticator trading card grading is the industry gold standard. Although other coin or trading card grading services are available, no company is as large, more trusted, or more respected. The more items Collectors Universe authenticates and grades, the more entrenched in the collecting community they become, further distinguishing themselves and truly making everyone else low-quality by comparison.
Low Customer Concentration
Companies with high customer concentration, where a single customer or a few customers are responsible for a significant revenue percentage, expose investors to the end customer's risks. Additionally, there is the risk that if the company does not have a significant competitive advantage (more on moats later in this series), these considerable customers will go elsewhere with their business. In our opinion, a perfectly wonderful company would experience immaterial losses from the loss of a single customer.
High Integration
Part of our niche at North Beach is investing in what we call essential service companies. A vital part of an essential service company and a wonderful company is high customer product or service integration. If a company's product or service is a key component of its customers' business process, they are less likely to switch. A perfect example of a company with high service integration is Stericycle, a medical waste disposal company that locates specially-designed containers at each customer location. If they were to close up shop overnight, medical facilities everywhere would be in a scramble to get rid of their biohazardous waste. Additional integration comes from the fact that these medical facilities are required by law to properly dispose of this waste – another reason Stericycle is the perfect example of an essential service company.
Low-Cost Proposition
An additional element of a wonderful essential service company is the overall cost of the service is low but value-additive. Electronic tolling services companies are a great example of a business that presents a low-cost proposition that adds value for users. Consider a freight company transporting goods across the country. Undoubtedly, this company's trucks will have to travel on toll roads at some point in the journey. These companies can either have drivers wait in line to pay tolls or partner with an electronic tolling company that allows automatic payment. The service's overall cost is not much higher than the tolls' total cost, and saving time and fuel adds value by not waiting in line.
Although most companies we analyze do not perfectly fit all five of the above criteria, these five business model attributes are what we are looking for when we first start researching a company. After all, if the ultimate goal is to buy wonderful companies at wonderful prices, you must know that its business model is wonderful first and foremost.
Next in the series is how we think about and define business moats at North Beach Holdings.
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