Traditional economic theory suggests that when companies are making too much profit, an invisible force pulls them back to reality, ensuring that all eventually operate under similar conditions. Imagine a bustling café in a newly developed neighbourhood. Its popularity would naturally attract more competitors to the area, each trying to outdo the other with different coffee blends, improved services, or more competitive prices. This increase in competition would eventually distribute customers and profits more evenly among all the cafés, representing how traditional theory views market equilibrium being restored as success attracts competition.
However, Wall Street strategist Michael Mauboussin, based on research by other experts, argues that this view is no longer fully applicable in all sectors today. Nowadays, some companies capitalize on a dynamic of increasing returns, where continued success brings even more gains, leaving their competitors behind. It’s no longer just about balance, but about an amplifying advantage that allows them to not only maintain or increase above-average profitability but also to dominate the market exclusively.
These companies challenge conventional rules in five distinct ways:
1. Economies of Scale
As a company grows, it can produce its goods or services at a lower unit cost, resulting in a competitive advantage. Amazon’s success story is a classic example. As Amazon expanded, it was able to purchase products (initially books) in large quantities and optimize logistics, significantly reducing per-item costs. This efficiency allowed Amazon to cover a wide range of retail categories, making it challenging for smaller retailers to compete on price or delivery speed.
2. International Trade
Brands like Apple demonstrate the power of international trade by using global supply chains to reduce production costs and access new markets. By manufacturing in countries with lower labor costs and selling in markets with higher purchasing power, Apple maximizes its profits and global reach.
3. Learning by Doing
Toyota’s advancements in car manufacturing illustrate the concept of learning by doing. Toyota introduced lean manufacturing and the Toyota Production System, continuously optimizing production processes and quality control, significantly reducing costs and improving production efficiency. This continuous improvement process has allowed Toyota to maintain a leading position in the global automotive market.
4. Positive Feedback and Networks
Facebook’s rise is an example of the combined effects of networks and positive feedback. Each new user increases the platform’s value, attracting more users and amplifying the growth cycle. This cycle is reinforced by personalized content and ads that improve as more data is collected.
5. Recombination of Ideas
Spotify revolutionized music listening by combining a vast streaming library with personalized playlists and algorithmic recommendations. This recombination of concepts created a new musical experience that caters to individual tastes.
What is the Opportunity Here?
These giants have established an exclusive club, while other companies face fierce competition. However, increasing regulation is questioning the social cost of these titans’ rapid growth. Past stories, like the decline of Nokia, Blackberry, and AOL, serve as reminders that today’s leaders may become obsolete in the future.
By exploring the concept of increasing returns, you’ll understand why some companies continue to win and dominate the stock market. This understanding can guide you to identify which companies are in control of their sectors and which may emerge as the next leaders. Use this framework as a tool to discover the next innovations and companies poised for significant growth. Remember, sometimes the best strategy is to leave the losers behind and let the winners of “increasing returns” continue to advance. This means that when investing or seeking business opportunities, it is crucial to identify those companies that are efficiently capitalizing on economies of scale, international trade, learning by doing, positive feedback, and recombination of ideas.
However, it is also essential to maintain a critical and analytical view, remembering that the competitive landscape can change rapidly. Companies that seem invincible today may face challenges in the future due to technological, regulatory, or consumer preference changes. Therefore, the key is to always be alert to market signals and adapt as necessary to ensure sustainable growth and a long-term competitive advantage.
Leave a Reply