Qualiport

[ December 4, 2000 ]

With Competitors Like These...

By Maynard Paton (TMFMayn)

Carburton Street, London -- If you're considering a company for the long term, then ensuring it has a substantial competitive advantage is all-important. From my experience, the most frequent reason for any company's profit disappointment is the impact of competition. No end of investment growth stories end in tatters as a company finds its rivals either undercutting it or ensuring its products become redundant.

Of course, over the long-term, the very best businesses to own are those without much competition. Take the Financial Times, owned by media giant Pearson (LSE: PSON). In the UK, it's the only financial newspaper around. Not only that, but the FT has been around for years without much competition, a fact that speaks volumes for its industrial "franchise". It's the brave investor who bets against the FT still being the number one financial newspaper in years to come.

Unfortunately, most companies just don't have the attractive business characteristics of the FT. Instead, they all have plenty of rivals to keep them on their toes. But even in the most crowded of industries, great long-term companies can flourish. But how can you find them? Here are two pointers.

Rivals

The first point is a superior record of profit growth. Take Qualiport members Independent Insurance Group (LSE: IIG) and PizzaExpress (LSE: PIZ). These two businesses operate in very competitive sectors, yet both have managed to create an impressive long-term record of profitability. There's obviously been something to set them apart from the run-of-the-mill insurers and restaurateurs. But of course, a historical record is just that. Historical.

The second point is perhaps not so obvious, but is just as important because it looks to the future. Rather than study the company itself, it pays to look at the competition.

This point was recently emphasised when I spoke to the management of both Independent Insurance and PizzaExpress. The management of both companies mentioned that, while their respective businesses were booming, rivals were falling by the wayside. This situation tells me that the two companies are continuing to create substantial competitive advantages for themselves. It also tells me that, with less effective competition, their future is more assured.

Let's take a closer look at the current state of affairs at both Independent Insurance and PizzaExpress.

Independent Insurance

Taken from this interview, here's a comment from Michael Bright, the Chief Executive of commercial insurer Independent Insurance:

"We've got a number of competitors who have gone out of business or... are pulling out of medium and large commercial (insurance)."

From the same interview, Andy Hawkes, Independent's Director of Marketing and E-commerce, had this to say:

"Just as an example, at our annual sales conference, one of the sessions was looking at some of the risk business issues of some of our competitors. There were nine examples put up. One was doing stupid things, in terms of whacking their rates up by 200%. Some were cutting back on the risk survey programs and their resources. Some were pulling out because the capacity doesn't exist anymore to write the business. We've got huge examples coming through where, because we are delivering a combination of service, resource, expertise and capacity, business that has been (previously) held by composite insurers are coming to us..."

Then read another remark from Michael Bright, this time taken from a recent trading statement:

"The buoyant trading conditions reported for the first half of the year continue. For the nine months to 30 September 2000, gross written premium rose by 62% on a year on year basis, to £614m... I cannot recall a period when the market environment has been so positive for Independent."

And then compare Independent to fellow insurer CGNU (LSE: CGNU), which had this to say about its commercial insurance activity at its interim stage:

"The profitability of the commercial property account during the first half of 2000 was adversely impacted by four large claims totalling £36 million. We continue to take underwriting and rating action in the commercial property and commercial liability accounts to reduce our exposure."

I'm sure if I looked further, I could find other insurers having a hard time in the commercial arena (companies do have a habit of burying disappointing news!). But the issue for Independent shareholders is this. Having competitors gradually leave the field ("reducing their exposure") is great news for the existing players. Not only will they gain greater market share, but having weary rivals throw in the towel isn't the best invitation to potential industry newcomers.

PizzaExpress

PizzaExpress is in a similar situation. Its pizzas are currently selling like hot cakes, whilst a lot of its competitors are suffering from profit starvation.

During another Motley Fool interview (to be published later this week), David Page, Chairman of PizzaExpress, commented: "Our like-for-likes are now 10% because twelve or eighteen months ago, we were having mild hysterics as our like-for-like sales were just 1%... There was a big oversupply eighteen months ago, when (competing) units hitting the High Street reached their peak. We couldn't work out whether it was their efficiency, our inefficiency, or just a sheer weight of numbers. We couldn't wait to find out. We had to do something about it."

Page outlined some of the actions PizzaExpress had to take: "We froze prices for eighteen months... to put the squeeze on our competitors. We put the wages up by quite a lot. This, of course, puts (more) pressure on competitors, because we get the best staff. The only way we could do it (improve our like-for-like sales growth) was by working on the platforms of our business and trying to destroy the opposition. Because it is a war of attrition. Business is warfare. Not only do you have to make your business more efficient, but half of your life must be spent making life very difficult for other operators."

Very significantly, Page put into context the recent 10% like-for-like sales growth performance that had resulted from the actions: "It's the highest underlying rate we've ever had since flotation, because we've had the improvements of the franchisees (acquired in 1996) which have been really distorting (in the past)."

Investors only have to look at the recent operational woes of City Centre Restaurants (LSE: CTC), Groupe Chez Gerard (LSE: GCZ), Belgo (LSE: BGO) and Oriental Restaurants (LSE: ORR) to see that PizzaExpress is a class apart in the restaurant sector. Reporting its best-ever underlying rate of growth while most other rivals are struggling is one sure sign that the company has built up a significant competitive advantage. And just like Independent, having rivals tripping up or selling out (e.g. Oriental Restaurants and perhaps City Centre Restaurants) all bodes well for PizzaExpress' future.

Summary

Both Independent and PizzaExpress are exceptional operators in difficult industries. I've no doubt that it's management talent that makes the ultimate difference. And although every manager will be upbeat about their company's prospects, for the investor, it always pays to look for independent evidence of the company's success. And where better than look at the competition?

A company notching up an impressive performance is a great sign. But even better is the company with an impressive performance coupled with many troubled competitors. Because this particular business must have something special, some sort of true competitive advantage, that most of the sector can't easily replicate. Alongside rival-free businesses like the FT, it's these competition-hurting businesses that investors should hunt for. Independent Insurance and PizzaExpress appear to have this characteristic in spades.

Where Next?

• Independently Wealthy -- Interview with Independent Insurance
• Visit the Independent Insurance discussion board
• Visit the PizzaExpress discussion board