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Do What You Do Best II:

Last week in Part I of Do What You Do Best I discussed my Value Rule of concentrating on companies who understand their strengths, core competencies and focus with precision and passion on being the best they can be in their respective industry.

So what are other examples of this approach?

We’ve already used Warren Buffett’s Coca-Cola as an example: they’ve focused on one singular product exclusively over a long period of time and repeatedly adapted what works well many times to grow in multiple markets around the world. They learnt from mistakes, continue to drive forward in the face of adversity and never deviated from their core product offering except to offer select niche products in the hope of creating brand loyalty similar to Diet or Cherry Coke with new initiatives.

McDonald’s is also another great example of how to apply this approach to investing. McDonald’s for a period of time over the past few years had undertaken my classic example of competing on price and suffered the consequences. Profitability declined, the stock price slowed (~$35) and it looked as though the company might suffer under continued pressures from the health-conscious consumer and public opinion. But what happened? The company overhauled its upper management to place those in a position of creating a strategic plan in the right places. They realized that the company had moved too far from its traditional core strengths and their product portfolio had ballooned into multiple product lines that conflicted with one another (McCafe, Salads, Krispy Kreme Donuts, etc). The company was offering too much choice and trying to target customers that rarely, if ever, made purchases at their restaurants.

What they instead began to focus back on was the repeat target market they had known for their entire existence. They streamlined their product offerings back to the core basics, increased margins and began implementing specific health conscious choices such as salads, a variety of new hot sandwiches and repositioned their McCafe product line to compete on a stronger taste and more cost-effective basis with Starbucks. They also concentrated on increasing their customer service in both delivery of their product & experience by renovating older restaurants and expanding to smaller, targeted, higher volume locations. They also took a more global view from a growth perspective and began strategically focusing on what specific regions of the world each McDonald’s division did best and reallocating management to where those competencies were needed.

One of the key things I look at when assessing a company is not only how they currently sell to their existing customer base, but also how they strategically attempt to increase the average transaction and increasing the lifetime value. Remember that customer lifetime value (attracting $1 customer) is how much each specific customer is worth to the company over the lifetime of that consumer. Companies with extensive loyalty programs often offer some of the most undervalued environments of applying this approach. Not only do these companies understand their target market with precision but they can also access the purchase behaviour, track purchase frequency & reach that customer with targeted offers in order to maximize sales opportunities. Companies who benefit from the Air Miles loyalty plan often benefit from access to this information. The alternate approach is to create your own and utilize that information with free rein and full access to all potential benefits. Although the initial costs are frequently very high, the benefits can be significant if executed effectively.

Companies such as Canadian Tire & Shoppers Drug Mart have benefited from their loyalty programs for years now. The Optimum program at Shoppers has benefited from the influence of past Air Miles executives as well as that program being a strategic focus by management at driving repeat sales through both in store purchases and accumulation of points through their CIBC Visa Card program. The recent announcement by Canadian Tire’s foray into financial services only strengthens their loyalty program and extensive database of customer information. All of this value-added information can have a massive impact on a corporations continued focus on driving revenues from consumer purchases targeted directly at their purchasing behaviour.

The greatest benefit in this approach allows me to stick to what I understand, know and excel at in order to reduce my risk of getting involved in an investment I know little or nothing about. I often attribute a large premium and enjoy a higher MoS in companies who focus on doing what they do best. What that means is by focusing on your company’s core strengths you have a better opportunity to diversify in new directions by using those core strengths as a foundation for a new strategic focus.

Imagine your corporation as a shield: doing what you do best is at the centre of that shield because it is always the strongest point. The centre of a shield is designed to absorb the largest impact by transferring force through the remaining weight outwards towards the perimeter. A company may navigate over time from the centre of their shield outwards; yet always maintain that single focal strength in order to protect itself from any damages further out on the exterior. This analogy is something many investors may align easily with WB’s often-used analogy of a company creating a wide moat around its operations. By protecting the core of a business from competition and securing a fortress in the centre, you can then mount opposition either pre-emptively or in defence to challenges you might encounter.

The important point to realize through all of this is that there are barriers and threats to companies who focus solely on core competencies. You always want to keep in mind that investing into a company with some flexibility offers more stability because if the market changes dramatically over the short-term, there is always the possibility that a company will struggle in adjusting their product or service to meet the new needs or demands of its customers. Although this hasn’t happened yet, for a long time Apple has excelled on its niche products. Of late, the company has expanded with a much more mainstream approach to its products and product development. If this signals a new strategic shift in the company’s growth strategy, then it offers an ideal opportunity for growth and the stock’s price recently has reflected that. But moving away from a core competency can most often result in two results: the first being that you achieve new core competencies by evolving the business into something bigger and better than it was; the second being that you leave yourself exposed to competition and if you fail on execution once out in the open (without a shield)…the company fails with you.

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