Just going through the book “The Innovator’s Dilemma” by Clayton Christensen. I have a few posts I’ll likely write that relate to the book — this is one of them.

The Innovators Dilemma talks a lot about a company’s culture, and why incumbent leaders of a certain technology are restrained from participating in a disruptive technology’s upside. Christensen names these attributes as the incumbent’s downfall: (1) Current customers aren’t served by new market; (2) New market is too small for large companies; (3) Use of new technology isn’t fully known yet; (4) Processes that help them with current business hurt them with new business; and (5) New technology isn’t good enough yet to meet higher-end market demand.

One solution to the above issues is to acquire another company that can take advantage of the disruptive technology. If done correctly, this can solve numbers 1, 2, 4, and 5 above.

Christensen breaks down the factors that affect what a company can and cannot do into Resources, Processes, and Values. Resources are people, equipment, brands, technology, customers, etc. Processes are how companies transform those resources into products or services of greater value. Values are standards by which employees make and prioritize decisions (think of a company’s “Core Values” of the Jim Collins variety).

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Insight: When looking at a company, what type of building is it?

Large companies (with competitive advantages) can be pyramids or skyscrapers. Both are large and have commanding presences. Both have high returns.

Pyramids are strong — you can’t knock them over. Skyscrapers are tall and strong, but they can be knocked over much easier. For a pyramid to be destroyed, it must start at the top, and slowly erode over time. After a while, only the foundation will be left. With a skyscraper, the foundation can be destroyed first, and the rest of the company will go with it.

Wal-Mart is a pyramid. Google is a skyscraper (for now — it seems that Larry & Sergey are in the process of building the foundation up). Berkshire Hathaway is a pyramid. Newspapers were pyramids — however, over the last two decades, they have been slowly chipped away starting from the top. Now, the foundation is about all that’s left.

Skyscrapers can be turned into pyramids over time.  But that requires great management and somewhat favorable circumstances. The time it took to build a company doesn’t necessarily tell you what type of building it is.

You can combine this analogy with Buffett’s moat analogy. Moats are barriers to entry — the wider the moat, the harder it is for competitors and disruptive technology to affect the company. But if the moat can be crossed, you’d much rather have a pyramid than a skyscraper.

Related:

After posting “The Restaurant Investor” earlier this week, I realized that some of my older articles were now gone (they used to be up on the Gannon on Investing blog, which has been taken down). So, I re-posted them on this site, and you can see both through the links below. Enjoy!

Quality Without Compromise
September 12, 2007–See’s Candies, Warren Buffett and the perfect investment.

Warren Buffett & The Washington Post
December 12, 2006

I wrote the following article for partners of Braewick Holdings LP and readers of this blog. The article is on the story of Steak n Shake, Sardar Biglari, and what it takes for a restaurant to succeed. I’ve included the introduction here, but the entire article is in PDF format through the link below:

“The Restaurant Investor” by Max Olson

In March, 2008, Sardar Biglari won the most important victory of his life. In an activist campaign to gain control of the board of directors of The Steak n Shake Company, Biglari and his partner received nearly triple the number of votes of the directors they were replacing.

It hadn’t been easy—their proxy fight with incumbent management had been going on for more than six months. Biglari and the entities he controlled first purchased seven percent of Steak n Shake during the summer of 2007. In August, the initial filing was made with the S.E.C. stating that Biglari had been in discussions with management. At this point, as with many activist investors, Biglari hoped that management would be open to his suggestions and criticisms of the company. He was the third largest owner of Steak n Shake at the time, holding more shares than all executive officers and directors combined. Only days earlier, C.E.O. Peter Dunn had unexpectedly resigned, stating his intent to “pursue other interests.” It seemed like the perfect time to reform the faltering restaurant chain.

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I am currently in the process of researching and writing a long article on the restaurant industry, or more specifically Steak n Shake, McDonald’s, and In-N-Out Burger. I should have it finished in a few weeks or so. In the mean time, please enjoy the following excerpt of the article on McDonald’s:

As Ray Kroc sat in his car, he watched a miracle unfold. The parking lot was full, the lines were long, and customers were leaving with an arm-full of food and a smile on their face. Kroc stopped a few to see what was going on: “You’ll get the best hamburger you ever ate for fifteen cents. And you don’t have to wait and mess around tipping waitresses.” He had travelled the country selling milkshake machines, visiting countless restaurants of all types. But he had never seen a merchandising operation like this. It was 1954; fourteen years after the McDonald brothers opened their small burger drive-in in the town of San Bernardino, California.

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“The stock ticker is like a tote board. It gives the public odds. A trader who wants to beat the market must have an edge, a more accurate view of what bets on stocks are really worth.”
—William Poundstone, “Fortune’s Formula”

Everyone needs an “edge” in both investing and business. If it were just a matter of finding and purchasing a security below its intrinsic value, anyone could go out and buy “The Intelligent Investor” and become great. In other words, value investing, in and of itself, is not a competitive advantage.

An “edge” is any method that gives an investor a leg up over the market by obtaining higher returns with lower risk. (Risk in this case being the risk of permanent capital loss–or the size of potential loss times the probability of loss.)

From what I’ve seen, there are six basic advantages, each of which can give investors an edge over the market:

1. Psychological - discipline, patience, and the avoidance of common biases and misjudgments. An extremely difficult advantage to have, but is probably the most common among good investors. (Easier said than done.)

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