Failure Patterns Final by Anil Tulsiram

Failure Patterns of Companies
Dependence on Government or they play a key role in Industry fortune. .................................................. 5

Renewable energy industry in large parts of Europe faced near bankruptcy due to abrupt withdrawal
of subsidy for renewable energy .............................................................................................................. 5
Favorable government contracts .............................................................................................................. 5
Undifferentiated business + Government Ownership .............................................................................. 6
Corporate Culture/Management .................................................................................................................. 6
Failure to scale up/ Cloning not easy ........................................................................................................ 6
Same banks get in trouble repeatedly Reason Corporate culture .................................................................. 6
Capital misallocation [i.e new areas where no competitive advantage] + Debt ...................................... 6
NOT a Win-Win situation for everyone .................................................................................................... 7
Controlling stockholders treats the business like a cash cow for their personal benefits ....................... 7
Ownership structure which by nature is short term oriented.................................................................. 7
Management which bet the bank on a single idea bad risk management as part of the DNA of the
firm ............................................................................................................................................................ 7
Throwing good money after bad Management not willing to let business die, even when no prospect
of producing any economic return over extended period of time. ....................................................... 7
Unwillingness to cede market share when irrational competition drives down potential returns ....... 7
A business which derives its key advantages from political clout. ........................................................... 7
Balance Sheet Risk ........................................................................................................................................ 7
Companies which need to raise capital from market continuously to survive ........................................ 7
Micro cap companies + High Debt [Total assets/Equity > 2x and EBITA/Fixed expenses < 1x]................ 7
Leverage + highly acquisitive companies .................................................................................................. 8
Growth from cheap credit supply ............................................................................................................. 8
Operating leverage + Financial Leverage + Cyclical business = Disaster................................................... 8
Debt Financed Bubbles ............................................................................................................................. 8
Threat of new entrants ................................................................................................................................. 9
Competition from low cost countries ....................................................................................................... 9
Low Entry barriers + Rapid technology change + Large number of rivals ................................................ 9
Stable industries:................................................................................................................................... 9
Consumer facing industries................................................................................................................... 9
Domestic companies facing threat from entry of global players ........................................................... 10
Threat of Substitutes................................................................................................................................... 10
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Anil Tulsiram ContrarianValueEdge.Wordpress.Com
Cyclicality can change customer behavior in unpredictable ways. ........................................................ 10

Technology disruption First they decline gradually and then suddenly .............................................. 10
HOW CAN WE KNOW IF A TECHNOLOGY IS DISRUPTIVE? .................................................................. 11
Competitive herding and Competitive hyper-activity results in decline in Brand Loyalty ..................... 11
Hyper mature Categories ........................................................................................................................ 12
Danger of newness/ Fast changing technology ............................................................................................. 12
Performance Oversupply [The Innovator's Dilemma] ................................................................................ 12
Performance oversupply four phases - functionality, reliability, convenience, and price ................. 13
Performance oversupply when customers shifts from functionality to reliability: ............................ 13
Good enough goods + influential middlemen + large scale + no genuine benefits to customer from
alternative products................................................................................................................................ 14
Fashion Risk/ Consumer Fads ................................................................................................................. 15
Customer Shifting Preferences ............................................................................................................... 15
High Bargaining Power of Buyer/Supplier .................................................................................................. 15
Concentrated Customers + No Pricing Power......................................................................................... 15
Concentration in any part of companys value chain ............................................................................. 16
Customers facing cyclicality in end markets + Prices of end product fluctuates + Depends on capital
expenditure of end users + undifferentiated products .......................................................................... 16
Ability to recognize the difference between a secular and cyclical change in companies ................... 17
Rivalry among Existing Firms ...................................................................................................................... 18
Capital Intensive + economically sensitive + Undifferentiated Business ............................................ 18
Commodity business + Capital intensive ...................................................................................................... 19
Too much equity [PE] or debt chasing the same industry ............................................................. 20
Ignoring interdependence of Value Chain .................................................................................................. 20
Seek Protection from Nature, more so when funded by debt ............................................................................ 20
Direct or indirect strong commodity link is an implicit bet on the commodity price............................. 21
What happened when Warren Buffet took call on oil prices? ........................................................... 22
Exception cement stocks .................................................................................................................... 22
Exception: Cyclical companies that are well capitalized + Dont lose money at bottom of the cycle .............. 23
Prefer cyclical companies that act counter-cyclical ....................................................................................... 23
Investor ....................................................................................................................................................... 24
Stay Simple, Stay Humble ....................................................................................................................... 24
Too many moving variables .................................................................................................................... 24
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Ability to handle volatility through financial strength low or no debt and significant disposable
income preventing the need to liquidate portfolio during inappropriate times. ................................... 24
A very long-term view about investing. .................................................................................................. 25
Examples of failures .................................................................................................................................... 25
Failure to scale up ....................................................................................................................................... 25
Bildner, Speciality Food store [Scalability is not easy] ............................................................................ 25
Indian Companies to watch out for ........................................................................................................ 25
Vaibhav Global ........................................................................................................................................ 25
Saipem, an offshore oil field company ................................................................................................... 25
Indian example - Aban Ofshsore ......................................................................................................... 26
Indian Example - Gujarat Rubber Reclaim .......................................................................................... 26
Some patterns ..................................................................................................................................... 26
Suzlon [Dependence on government + debt fueled acquisition] ........................................................... 26
Indian Infrastructure industry, Mining, Telecom, Power, and the ancillary industries depended on
these industry ......................................................................................................................................... 27
Gammon India..................................................................................................................................... 27
IVRCL ................................................................................................................................................... 27
Jain irrigation [post 2007 period]........................................................................................................ 27
Noida Toll Bridge [Change in favorable contract by govt.] ..................................................................... 27
Cabbage Patch Kids [Consumer fads/Fashion risk, Threat of Substitute] .............................................. 27
Dental Implant Nobel Biocare [Good enough goods + Influential middlemen +Performance
oversupply, Threat of Substitutes].......................................................................................................... 27
Indian company to watch out for: Plywood Industry ......................................................................... 28
Performance oversupply example: Intuit accounting software [Threat of Substitutes] ........................ 28
Tata Steel [Balance Sheet risk]................................................................................................................ 28
Electrosteel ............................................................................................................................................. 29
Jain irrigation [Early 1990s]..................................................................................................................... 29
Ignoring interdependence of Value Chain .............................................................................................. 29
Ford lost market share to GM by failing to see importance of credit to customers .......................... 29
Nomacorc captured 20% market share as traditional cork makers for wine bottles ignored end
consumer ............................................................................................................................................ 29
Valeant Pharmaceuticals......................................................................................................................... 30
Enron, India ............................................................................................................................................. 30
Appendix ..................................................................................................................................................... 30
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Success = Strategy + Execution [which depends on management personality] + Luck + avoiding

technology disruption ............................................................................................................................. 30
Look beyond measurable performance in terms of ROE and growth to judge quality of company and
quality of management:.......................................................................................................................... 32
Alice on How Warren buffet gives imp. to patterns ................................................................................... 34
Warren Buffet AGM 2016 on Pattern Recognition ................................................................................. 35
How to think about valuation of cyclical companies ........................................................................ 35
Jain irrigation [Early 1990s]..................................................................................................................... 36
Groupon Business Model ............................................................................................................................ 39
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Dependence on Government or they play a key role in Industry fortune.

We are wary of businesses where governments play a large role in determining
corporate fortunes. Government actions, which are political and therefore often
unpredictable, can both catapult a business to prosperity and cut it down. The issue is
acute for companies that rely on fixed infrastructure, such as telecom operators, utility
and oil producers, and mining companies. Since wiring, power plants, oil wells, and
mines cannot readily be moved, governmental impositions from carbon taxes to
excise taxes on oil and mineral extraction are neither predictable nor avoidable.
Source: Quality Investing Owning the best companies for long term
Renewable energy industry in large parts of Europe faced near bankruptcy due to abrupt
withdrawal of subsidy for renewable energy
Before the global financial crisis began in 2008, generous government subsidies led
many companies to think the renewable energy business offered great returns. The
subsidies benefitted the companies building vast solar parks and wind farms, and also
created a tremendous boom for suppliers of everything from wind turbines to silicon
wafers. When times abruptly changed and governments realized they needed to cut
costs, subsidies to renewables were ready targets. With a few small government
decisions, renewable energy companies from Norway to Portugal went from explosive
growth to near bankruptcy. Such episodes, which recur in history, are why
government industrial assistance or protection should be viewed as transient, no
matter how noble or long-term the governments intentions
Source: Quality Investing Owning the best companies for long term
Favorable government contracts
Other scenarios calling for caution are those involving favorable government contracts.
Although often lucrative while they last, such arrangements can be changed or
renegotiated at governments whim, which often occurs if governments decide they are
too favorable to business. The effect caps the economic upside in many areas when the
government is counterparty. This is a perennial problem with government concessions,
such as mining contracts. While in theory concession companies are handed
monopolies, monopoly-like profitability seldom follows over the long term. Aside from
direct power to alter contract terms, government wields an array of tools such as
taxes, duties, or regulation that can wipe out contractual advantages. Quality
Investing
Written agreements do not amount to much in India. The legal system takes long to
enforce a contract and/or provide compensation. If the counter-party (especially if the
counter-party is the government) does not honour its commitment, there is little that the
shareholders or promoters can do. Most of the infrastructure companies in India have
realised this the hard way. Even if the counter-party (which could be the government) is
willing to adhere to the contract, there is a legal risk. The courts may strike down an
agreement or may pass an order in public interest that goes against what some in the
western world would see as commercial principles. To illustrate, spectrum and telecom
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licences in the infamous 2G scam were revoked. Similarly, coal block allocations were
revoked. In the case of a contracted toll road in the National Capital Region (NCR), the
toll was abolished for a private company on the grounds that the waiting time to pay the
toll was too long and it was causing congestion. We have had instances where the
patent holders right to exclusive sale of medicines was revoked on the grounds that the
medicine was for treatment of cancer and that most people were not able to afford the
patent holders prices for the medicine. [Rajeev Thakkar article in Mint]
Undifferentiated business + Government Ownership
Even private sector in such businesses will struggle eg. Fertilisers
Corporate Culture/Management
Failure to scale up/ Cloning not easy
In a recent conference an investor with more than 30 years of value investing experience
said that risk in scalability is highly underappreciated.
Same banks get in trouble repeatedly Reason Corporate culture
The banking sector is not generally a rich mine of quality businesses, but there may be a
few hidden low-cost winners in the mix. As a sector, banking combines many elements
we dislike: commodity products; high leverage; regulation and government support; and
cyclicality. Operationally, gross margins of banks are expressed by net interest margin,
the difference between the cost of funds (to depositors or others), and the price charged
for funds (to borrowers). The margin is determined largely by uncontrollable
macroeconomic conditions and available levers are often dangerous, such as charging
too little interest or ignoring borrower credit risk. The latter poses an additional hidden
cost: loan losses can sometimes take years to manifest. So banks can achieve high net
interest margin, as well as high profit for years, not by being good bankers, but by being
imprudent.
Given the risk inherent in the banking and the narrow zone of cost-consciousness
necessary to qualify as a quality company, we stress corporate culture when
evaluating banks. As the financial crisis of 2008 reminded everyone, the same
banks seem to get into trouble repeatedly. It is unfair to blame management alone,
as they come and go, but corporate culture, a more permanent feature, plays an
important role in banking and other businesses. Quality investing
Capital misallocation [i.e new areas where no competitive advantage] + Debt

We're looking for companies with weakening moats, often coupled with a resulting
deployment of capital into areas in which they have no competitive advantage. Even
better is when they're deploying not just excess capital, but leveraging the balance
sheet to do so. James Crichton, Scout Capital [Check Nirma has done quite similar to
this..] Eg. Jain Irrigation in 1990s expanded into various fields
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NOT a Win-Win situation for everyone

Is the business model a win-win situation for the entire ecosystem? Do all the
stakeholders of the company benefit or is the company predatory with some
stakeholder, for ex: selling credit to poor customers? Does the product involve high
incentive for the employee to sell, but traps customer in a long term deal with bad
results for them? [Mohnish Pabrai]
Controlling stockholders treats the business like a cash cow for their personal benefits
Ownership structure which by nature is short term oriented
PE controlled firms
Management which bet the bank on a single idea bad risk management as part of the DNA of
the firm
Source : Prof Sanjay Bakshi blog post
Throwing good money after bad Management not willing to let business die, even when no
prospect of producing any economic return over extended period of time.
Unwillingness to cede market share when irrational competition drives down potential returns
A business which derives its key advantages from political clout.
Balance Sheet Risk
Companies which need to raise capital from market continuously to survive
Over the years we have also become very leery, based on experience, of companies
that need to raise capital in order to survive and prosper. It's not a good thing to be
vulnerable to the whims of the capital markets, which can close rapidly and surprisingly.
Jeffrey Tannenbaum, Fir Tree Partners
Micro cap companies + High Debt [Total assets/Equity > 2x and EBITA/Fixed expenses < 1x]
You can't take a long-term view without confidence that the company's financial
condition will allow it to meet out-of-left-field macro or micro challenges. There's an old
saying that the balance sheet doesn't matter until it's all that matters, so we want to be
ahead of that. That's particularly important in smaller companies, which are generally
built on more fragile foundations than big, diversified ones. We measure leverage fairly
broadly by looking at the ratio of assets to stockholders' equity. This allows us to see
risk items that might not otherwise show up if we were primarily focused on long-term
debt, like higher-than-usual levels of receivables , or bulging inventories, or increasing
short- term bank lines of credit that may have a way of turning into more permanent
debt. Our general rule of thumb, for non-financials, is to look for a 2: 1 ratio of assets to
stockholders' equity, which we consider a reasonable margin of safety. Whitney
George, Royce & Associates
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After learning some hard lessons during the financial crisis, we instituted a rule that any
ratio of total assets to shareholders' equity above 2.5 to 1 is an exception, which doesn't
automatically mean we won't buy it, but each individual position size will be limited and
we won't ever have more than 10 percent of the portfolio in such exceptions at one time.
That's nothing more than recognition that when you're wrong with a leveraged business
model, the hit to the stock price can just be too fast and too damaging. Robert
Olstein, Olstein Capital Management
Leverage + highly acquisitive companies
The biggest mistakes we ever made involved a few investments in highly acquisitive
companies that had balance sheet leverage. The big lesson is that when you mix
financial risk, in the form of leverage, with operating risk, from having to integrate
acquisitions, you compound the overall risk dramatically. If we come across a levered
acquisitive company today, we're most likely to short it, hedge it or pass on it. Jeffrey
Tannenbaum, Fir Tree Partners
Growth from cheap credit supply
Check to what extent company and the relevant sector got benefit of cheap credit to
particular sector. If availability of credit reverses, due to tightening or due to bad debts,
entire sector will collapse (Howard Mark)
Operating leverage + Financial Leverage + Cyclical business = Disaster
Debt brings varying interest rates, restrictive loan covenants, and scheduled due dates
that put considerable control over value creation in the hands of lenders rather than
managers, to the detriment of owners. Risks are particularly great for companies
exposed to cyclical end markets. Since cycles invariably defy expectations, borrowers
and lenders alike often miscalculate the line between reasonable and excessive
leverage. Drastic mistakes regarding debt levels congregate in two related situations.
The first are companies that combine substantial financial debt with high operating
leverage. Amid periods of economic expansion, the operating leverage enables growing
revenue at lower cost, enabling cash flows that comfortably cover repayment of
borrowed money. But in economic downturns, high operating leverage readily translates
into rapidly deteriorating cash flows and difficulty meeting debt obligations. Overlooking
this feature of debt is a trap for the unwary and one that even experienced investors are
prone to fall into. [Source: Quality Investing: Owning the best companies for the long
term]
Debt Financed Bubbles
The first and most lucrative category of short ideas are the booms that go bust . We've
had our most success with debt-financed asset bubblesas opposed to just plain asset
bubbles where there are ticking time bombs in terms of debt needing to be repaid,
and where there are people ahead of the shareholders in the bankruptcy or workout
process. The debt-financed distinction is important. It kept us from shorting the Internet
in the 1990s that was a valuation bubble more than anything else. Real estate crash
in United States [Jim Chanos]
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Threat of new entrants

Competition from low cost countries
If a company is facing strong competition from a more efficient competitor with lower
costs, it is perhaps best to utter those comforting words "no, thank you" and move on to
the next candidate. (Tweedy and Browne)
Low Entry barriers + Rapid technology change + Large number of rivals
The Delusion of Absolute Performance is hugely important because it suggests that
companies can achieve high performance by following a simple formula, regardless of
the actions of competitors. If left unchecked, managers may pay attention to a
misleading set of issues. The Evergreen Project wasnt alone in this basic
misconception the same delusion was implicit in Built to Last, where Collins and
Porras claimed that following a handful of steps provided a blueprint for enduring
success without any mention of rivals or any appreciation of the dynamics of industry
competition. Yet once we see that performance is relative, it becomes obvious that
companies can never achieve success simply by following a given set of steps, no
matter how well intended; their success will always be affected by what rivals do. The
greater the number of rivals, and the easier for new competitors to enter the market,
and the more rapidly technology changes, the more difficult it is to sustain success.
Thats an uncomfortable truth, because it admits that some elements of business
performance are outside of our control. Its far more appealing to downplay the relative
nature of performance or ignore it completely. Telling a company it can achieve high
performance, regardless of what competitors do, makes for a more attractive story. The Halo Effect: ... and the Eight Other Business Delusions That Deceive Managers
Stable industries:
These industries can be described as dowdy, but a better word might be stable. They
were less subject to radical changes in technology, were less susceptible to shifts in
customer demand, and may have had less intense competition. All of which meant that
companies in these industries had a better chance of racking up consistent
performance, year after year, than did companies in more turbulent industries. High tech
companies, by contrast, were much less likely to string together fifteen years of high
performance. - The Halo Effect: ... and the Eight Other Business Delusions That
Deceive Managers
Consumer facing industries
It makes a wonderful story to claim that anyone can become Great, but the only
companies that met Collinss criteria of fifteen years above the market average
happened to be active in consumer products like cigarettes and razor blades and toilet
paper, or consumer retailing like drugstores, or financial services like retail banks and
mortgages. Collins remarked that companies can become Great even in unlikely places,
but a fresh look at the evidence suggests that he got it backward. If the criterion is
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fifteen consecutive years of high performance, it may be more accurate to say that only
companies in stable industries are likely to achieve Greatness. - The Halo Effect: ... and
the Eight Other Business Delusions That Deceive Managers
Domestic companies facing threat from entry of global players
Case studies:
Caf Coffee day vs Starbucks

PVR vs Cinemax
Threat of Substitutes
Cyclicality can change customer behavior in unpredictable ways.
Cyclicality can change customer behavior in unpredictable ways. During flush periods,
companies spend. Budgets are generous and getting quality equipment and services
delivered on time takes precedence over cost. But when times turn tough, cost
consciousness rises. Besides initial cutbacks to capital expenditure, most companies
reexamine their cost structures. Many find they have been overpaying suppliers. After
all, most suppliers to cyclical industries are adept at aligning pricing with customers
budgeting. Some customers even demand across the board supplier price cuts.
A recent example occurred in the air-freight industry. Over recent decades, many
companies developed the habit of shipping certain goods by air, which is faster but far
more costly than shipping by sea. When the global financial crisis hit, many shifted back
to sea freight. They found that, with minor adjustments, their supply chain could function
equally well with a substantially smaller component of goods shipped by air. Even when
good times returned, they saw no reason to revert.
[Quality Investing]
Technology disruption First they decline gradually and then suddenly
We've made mistakes in recent years investing in secularly challenged businesses,
including newspapers, yellow-pages publishers, printing companies, and bookstores.
The pace of change has accelerated in many of these types of businesses and it's
proven challenging for us to stay ahead of that. We've essentially concluded that the
simplest way to avoid mistakes in secularly challenged industries is to just not invest in
them. Eugene Fox, Cardinal Capital We're very unlikely to make the bet that a secular
decline in an industry or that a company just won't be as bad as the market expects.
You can make tempting valuation arguments at certain points for businesses with
secular headwinds, but modeling the trajectory of the decline is very difficult. In the late
1990s if you were first starting to model the decline in consumer photo film for Kodak,
you likely assumed a slow single-digit annual percentage decline over time. That's what
happened for a few years, but then it started declining by 20 30 40 percent per year,
which had a large impact on profitability. We've also found in these types of companies
that the risk of misallocation of capital is high. Management may have a lot of free cash
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flow at their disposal, they're anxiously looking for ways to grow, and they often end up
paying too much for acquisitions when they find them. Canon Coleman, Invesco
You do have to recognize if a disruptive technological or structural industry change is
underway or relative value will point you to a lot of value traps. We're always asking
whether there's a transitory disruption to a business or whether there's a point of
discontinuity, as was the case with Eastman Kodak. Brian Barish, Cambiar Investors
HOW CAN WE KNOW IF A TECHNOLOGY IS DISRUPTIVE?
1) Note trajectories of performance improvement demanded in the market versus the
performance improvement supplied by the technology; 2) The first step in making this
chart involves defining current mainstream market needs and comparing them with the
current capacity of electric vehicles. To measure market needs, I would watch carefully
what customers do, not simply listen to what they say. 3) They will only be disruptive if
we find that they are also on a trajectory of improvement that might someday make them
competitive in parts of the mainstream market. To assess this possibility, we need to
project trajectories measuring the performance improvement demanded in the market
versus the performance improvement that electric vehicle technology may provide.
Innovators Dillemma
Competitive herding and Competitive hyper-activity results in decline in Brand Loyalty
[I guess more so in Hyper mature, highly penetrated and slow growing FMCG items]
Well, its not that I believe brand loyalty is altogether dead; it clearly isnt. As I said, most
folks are picky about somethingmy assistant loves his Pradas; the kids in my town
love their Hollisters. Its just that brand loyalty seems to have become more elusive
than ever. The phenomenon seems particularly apparent once you begin eliminating
some of the flashier categoriesfashion, shoes, accessories, etc.around which
people tend to focus their most high-profile consumption activity. Take these away, and
youre really not left with much loyalty at all, at least that I can observe. In fact, I would
wager that for most people, the number of categories in which they feel no fidelity
toward any particular brand far outnumbers the number of categories in which they do; I
would also wager that the balance is tipping further with each passing day. There are
literally dozens of brands competing for my affection in categories such as hotels
and retail banking and energy bars, for example, and I feel loyalty to exactly zero
of them. The teenagers in my town are bombarded with choices with respect to the
kinds of juices they drink and the foods they eat, and the vast majority of these brands
manage to garner a faddish passing interest at best.
Cereal can be described as a category in which all the brands are different or all the
brands are the same, depending on your point of view. So can sneakers. Or bottled
water. Its easy to be a Hagen-Dazs loyalist when Hagen-Dazs is the only major
player in the premium ice cream game; when the market is packed with premium
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clones, Hagen-Dazs loyalists are by definition going to be harder to find. My

husband and I routinely disregard brands across an array of categories ranging from
shampoo to dishwashing soap, to an extent that our parents would never have dreamed
of. And its not because were all that different than they were, but because were
making our purchases in a very different market context. Once the dual dynamics of
competitive herding and competitive hyper-activity begin to dominate a category,
the category itself starts to become incompatible with brand devotion. I really
believe this to be true. This is what I mean when I say that brand loyalty is becoming
harder to come by. What Im saying is that when I look around me, I see too many firms
in too many categories engaged in precisely the kind of competitive cycle that tends to
preclude its emergence. [Source: Different: Escaping the Competitive Herd ]
Hyper mature Categories
The laundry detergent category is a hyper-mature category. The sneaker category
is a hyper-mature category. The cellular industry is a hyper-mature category. The
products within them have gotten better over time (augmentation-by-addition), and
partly because there are more product choices to be had (augmentation-bymultiplication)but Ill also describe how the reality is a lot more complicated than this.
In so many of these categories, overall customer satisfaction levels havent
budged much at all over the years. What this means is that these are categories in
which companies are literally running to stand still. This, in fact, is a telltale sign that
a category has achieved hyper-maturity: Overall growth in the category has slowed to a
trickle even as the competitive hyper-activity in the category has become more frenzied
than ever. [Source : Different: Escaping the Competitive Herd ]
Danger of newness/ Fast changing technology
In some industries, history is less important. Nintendo is one of the most iconic brands in video
gaming. Founded as a playing card manufacturer in 1889, it produced its first video game in 1977
and owns video-game icons like Super Mario. Yet, before finding partial redemption with its Wii
product, it floundered. By the early 2000s, newer rivals such as Microsoft Xbox and Sony
PlayStation had overtaken it. The fact that Microsoft was only founded in 1981 or that PlayStation
was launched in 1994 didnt matter. Superior innovation from competitors diminished brand
appeal. The Nintendo case illustrates how brands are more vulnerable when novelty and
fast-changing technologies play a large role in the benefits it offers. Innovation-driven
vulnerability extends beyond technology to affect many industries, such as the fast-changing world
of fashion. Innovation is a perennial challenge for apparel brands. - Quality Investing: Owning the
best companies for the long term
Performance Oversupply [The Innovator's Dilemma]
In each of the several industries explored, technologists were able to provide rates
of performance improvement that have exceeded the rates of performance
improvement that the market has needed or was able to absorb. Historically, when
this performance oversupply occurs, it creates an opportunity for a disruptive technology
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to emerge and subsequently to invade established markets from below. Once

the performance level demanded of a particular attribute has been achieved, customers
indicate their satiation by being less willing to pay a premium price for continued
improvement in that attribute. Hence, performance oversupply triggers a shift in the
basis of competition, and the criteria used by customers to choose one product over
another changes to attributes for which market demands are not yet satisfied. Eg.
Desktop PC market. A product becomes a commodity within a specific market segment
when the repeated changes in the basis of competition, as described above, completely
play themselves out, that is, when market needs on each attribute or dimension of
performance have been fully satisfied by more than one available product. The
performance oversupply framework may help consultants, managers, and researchers to
understand the frustrated comments they regularly hear from salespeople beaten down
in price negotiations with customers: Those stupid guys are just treating our product like
it was a commodity. Cant they see how much better our product is than the
competitions? It may, in fact, be the case that the product offerings of competitors in a
market continue to be differentiated from each other. But differentiation loses its meaning
when the features and functionality have exceeded what the market demands.
Performance oversupply four phases - functionality, reliability, convenience, and price
Once two or more products credibly satisfy the markets demand for functionality,
however, customers can no longer base their choice of products on functionality, but
tend to choose a product and vendor based on reliability. As long as market demand for
reliability exceeds what vendors are able to provide, customers choose products on this
basis and the most reliable vendors of the most reliable products earn a premium for
it. But when two or more vendors improve to the point that they more than satisfy the
reliability demanded by the market, the basis of competition shifts to convenience.
Customers will prefer those products that are the most convenient to use and those
vendors that are most convenient to deal with. Again, as long as the market demand for
convenience exceeds what vendors are able to provide, customers choose products on
this basis and reward vendors with premium prices for the convenience they offer.
Finally, when multiple vendors offer a package of convenient products and services that
fully satisfies market demand, the basis of competition shifts to price. The factor driving
the transition from one phase of the buying hierarchy to the next is performance
oversupply.
The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail
Performance oversupply when customers shifts from functionality to reliability:
Another useful conception of industry evolution, formulated by Geoffrey Moore in his
book Crossing the Chasm, 3 has a similar underlying logic, but articulates the stages in
terms of the user rather than the product. Moore suggests that products are initially
used by innovators and early adopters in an industry customers who base their
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choice solely on the products functionality. During this phase the top-performing
products command significant price premiums. Moore observes that markets then
expand dramatically after the demand for functionality in the mainstream market has
been met, and vendors begin to address the need for reliability among what he terms
early majority customers. A third wave of growth occurs when product and vendor
reliability issues have been resolved, and the basis of innovation and competition shifts
to convenience, thus pulling in the late majority customers. Underlying Moores model is
the notion that technology can improve to the point that market demand for a given
dimension of performance can be satiated. This evolving pattern in the basis of
competition from functionality, to reliability and convenience, and finally to price has
been seen in many of the markets so far discussed. In fact, a key characteristic of a
disruptive technology is that it heralds a change in the basis of competition. - The
Innovator's Dilemma: When New Technologies Cause Great Firms to Fail
When performance oversupply has occurred and a disruptive technology attacks the
underbelly of a mainstream market, the disruptive technology often succeeds both
because it satisfies the markets need for functionality, in terms of the buying hierarchy,
and because it is simpler, cheaper, and more reliable and convenient than mainstream
products.
Good enough goods + influential middlemen + large scale + no genuine benefits to customer
from alternative products
14
Fashion Risk/ Consumer Fads

The toy industry has historically been fertile ground for fads to take root and flourish.
Typically such fads are single products or brands whose appeal spikes in one year and
then plummets within a few. Generally there is no practical need for the product and
often there is some element of associated hype, such as a popular record or other
gimmick. While catching a fad early can be lucrative, given stellar initial growth rates,
the spectacular fall on the horizon dooms the idea as a long-term investment
proposition. [Quality Investing]
The last big one would be consumer fads. This is when investorstypically retail
investors use recent experience to extrapolate ad infinitum into the future what is
clearly a one-time growth ramp of a product. People are consistently way too optimistic
and underestimate just how competitive the U.S. economy is in these types of things :
Cabbage Patch Kids in the 1980s, NordicTrack in the early 1990s, George Foreman
grills in the early 2000s. James Chanos, Kynikos Associates
Customer Shifting Preferences
In todays food industry, companies likewise grapple with increased interest in nutritional
content rather than the historical focus on taste. In retailing, the historical competitive
advantage that the consumer benefit of proximity offered is reduced by rising consumer
preference for online shopping. No one can control such shifts, but we try to consider
them as part of an overall assessment of the durability of competitive advantages.
[Quality Investing]
Case studies
Junk food industry [McDonalds, PizzaHut, Dominos etc]
Ayurveda
Tobacco Industry
High Bargaining Power of Buyer/Supplier
Concentrated Customers + No Pricing Power
Clues as to the relative attractiveness of the two industries appear by probing who the
customers are and how the selling is done. In contrast to the soft drinks industry, the
aircraft industry sells to a concentrated industrial customer base and every individual
sale is negotiated hard. This puts pressure on pricing and, ultimately, industry
profitability. In any sector, it is important to assess whether competition is as real
at the micro-level as it appears at the macro-level. Sometimes what seems to be a
competitive market is rather a latticework of smaller monopoly-like structures
where all participants extract high profits. - Quality Investing: Owning the best
companies for the long term
15
Companies can sell large numbers of lower-priced goods to corporate customers where
purchase orders are made and approved without significant involvement of senior
managers or the general counsels office. Second, sellers tend to fare least well on
products sold to corporations through bidding processes or organized negotiations
where extensive product comparisons spell intense competition among suppliers that
drives price down. Above all, the more a corporate decision is driven by price rather
than other factors, the less attractive it is from a sellers viewpoint. - Quality Investing:
Owning the best companies for the long term
Concentration in any part of companys value chain
Besides the negative consequences of losing a key customer, the threat of defection
confers bargaining power that big customers can use to extract economic concessions
that alone or in aggregate may pose significant costs. Concentration risk extends
beyond customers to include suppliers on the production end, who may charge higher
prices, and distributors on the sales end, who may offer lower prices. [Quality Investing]
Customers facing cyclicality in end markets + Prices of end product fluctuates + Depends on
capital expenditure of end users + undifferentiated products
Many companies have customers facing cyclicality in end-markets, meaning that
demand for their own products fluctuates, but not necessarily price levels.
Examples appear among suppliers of equipment or services to industries such as
paper, mining, oil and gas, or agriculture. To exclude investing in all such companies
would be unwise. In fact, nearly all companies selling to the industrial sector face the
problem to varying degrees, including quality businesses such as Atlas Copco and
ASSA ABLOY. Rather, we focus on whether the companys economic model depends
on the customers capital expenditure or operating costs. A business that is solely linked
to customers capital expenditure makes for a much more complicated investment than
one linked to their operating costs.
For a company whose profits are dependent on such capital expenditure, it is extremely
difficult to predict results. Even a rough guess requires insight into both commodity
pricing and how miners evaluate investing in new capacity at different price levels. A
more reliable estimate would consider long-term demand trends for the given
commodity. While some industrial economists with related expertise might be able to
model this, we find it too challenging to translate into a predictable cash flow pattern and
therefore tend to steer clear. On the other hand, for a company whose profits tie to
customers operating costs, cyclicality poses less risk of disruption and remains
relatively predictable. Even during cyclical downturns when prices are low, most
producers maintain existing facilities and even production levels while cutting capital
expenditures. Quality Investing
When oil prices fall, producers still produce. So long as production is substantially
maintained, suppliers of products tied to production and operating costs typically face
less disruption from the cycle. We call these flow products. Mills have to be
maintained. Production equipment requires spare parts and regular maintenance. Tests
16
must be run on extracted oil or minerals. So companies with most of their profit pools
from flow products tend to experience less profit erosion during downturns. Likewise,
during upturns, theirs are not among the products that spike in demand, aiding
prediction. In both phases of the cycle, this is especially true for differentiated rather
than commoditized products. Therefore, we like to focus on flow products with
genuine differentiation benefits.
The relative attractiveness of flow products versus capex products offers two broader
lessons. First, even if companies sell to less cyclical industries, steady revenue streams
from flow products are typically more attractive than those dependent on capex. Partly,
this is due to the fact there is often more pronounced cyclicality in capex spending than
many investors estimate. If economic uncertainty runs high, all kinds of customers hold
back on spending. The lesser predictability is undesirable. Second, spending on flow
products tends to invite less customer scrutiny. Capital investments, whether on a
drilling rig or a new office building, always receive serious price attention. Flow
products, on the other hand, slip more easily below the radar because of their smaller
size and greater regularity.
Downturns can even affect flow products. Some customers cut costs by stretching out
equipment maintenance schedules and deferring overhauls or repairs. Some move to
self-service maintenance or increase use of non-original spare parts. Companies can
become more inclined to buy equipment or services from second tier providers,
sacrificing reliability for cost. [Quality Investing: Owning the best companies for the long
term]
Ability to recognize the difference between a secular and cyclical change in companies
Cyclicalitys underpinnings can be murky, especially when expansionary periods (the
swells) are sustained for a surprisingly long time. People begin to believe that cyclicality
has been conquered, and growth starts to look sustainable even when it is not. After all,
cyclicality is not something companies like to admit to. If things stay good enough for
longer than usual, they are inclined to perceive the great performance as the new
normal. An acute problem with no-cyclicality arguments, however, is that they are the
most dangerous when they look most reasonable. When expansionary periods last
longer than before, companies exposed to the cycle will look the most compelling. Their
five-year and even ten-year track records can look so strong as to make it seem illogical
to consider what occurred 20 years earlier. A more pernicious situation arises when
companies that dont necessarily seem cyclically exposed start to benefit from
cyclicality. Unsustainable booms in certain countries or industries can benefit
companies that normally wouldnt be exposed to such effects. Distinguishing between
sustainable structural growth for a company and mere cyclicality is not always easy. If
growth in a historically stable company gradually increases, it is easier to assume that
higher structural growth rates or market share gains are driving it than that cyclicality
has crept into the equation. Sustainably higher growth has a different effect on a quality
17
companys future value creation than a cyclical growth spurt. Underestimating the
cyclical effects can therefore impact materially on investment performance.
[Quality Investing: Owning the best companies for the long term]
Cycles can vary enormously in length: for some industries, ten or even 20 years of
history provides insufficient context. To gauge this, and help improve the understanding
of a cyclical company through the cycle, it is important to analyze the information
available as far back as possible, preferably several decades.
Further, while focusing our analysis on demand, the driver of sales growth, we had
ignored the axiom that it is usually supply that arrests profit growth in cyclical industries.
When capacity is tight, the backlog grows at double-digit rates, and the company can
name its price. An investor is unlikely to notice that some projects are being executed
poorly, key people are leaving, or new contracts are too risky. Quality Investing
Investors must be careful not to confuse cyclical and secular growth when assessing long-term
market potential. Many growth investors have been singed by chasing cyclical upticks in market
demand that they believed to be secular growth trends. The point is that secular growth can often
appear cyclical at individual companies, and vice versa, so investors must be careful to distinguish
between the two by diligently assessing the underlying drivers of the growth. [ Benjamin Graham
and the Power of Growth Stocks]
A third quality that I believe all great investors share is the ability to recognize the difference
between a secular and cyclical change in companies they have carefully studied. If a company
they have studied and believe in is down because of a cyclical change, successful investors use
the opportunity to purchase as much as they can as quickly as they can. They do not care and are
not influenced or frightened by market conditions, etc. However, if a company is in trouble due to
secular change, successful investors will take their losses and back away. The ability to recognize
secular and cyclical cycles cannot be taught, in my opinion. Rather, it is an instinct or talent that
has been honed over many years of arduous work. In other words, the great investors, just like the
great champions in other fields, can divorce themselves from their emotions and just play the game
[The Worlds 99 Greatest Investors:]
Companies that are prosperous today may depend on forces that are susceptible to unpredictable
but rapid change. Many appear stronger than they are due to cyclical growth, the temporary
tailwinds of fickle consumer trends, or technological leadership vulnerable to disruption. While
such forces are too nuanced to automatically rule out consideration of companies exposed to them,
they warrant greater scrutiny because of the significant downside risks. [Quality Investing: Owning
the best companies for the long term]
Rivalry among Existing Firms
Capital Intensive + economically sensitive + Undifferentiated Business
Certain businesses, by their very nature, have a frontloaded and capital intensive base.
Obviously, such businesses face great challenges because capex is a certainty while revenues
and profits remain conjecture till they happen. So, one doesn't get a chance of calibrating the
18
capex program with emerging business realities. If the business reality alters adversely, heavy
capex incurred upfront may be exposed to heavy losses. Often, such capex programs tend to be
lumpy and stretch over a long period oftime. If for some reason, that gets elongated, ROCE
suffers adversely. Airlines, hotels, theatre screens, retailing, metals, oil exploration and many
other such businesses have this basic flaw in the character of the business. Take, for example,
an airline business. Assumed future demand determines present and heavy capex in capacity
creation. But the business itself is subject to material risks in the form of volatile revenue,
inflexible costs and recurrent, heavy and lumpy capex. Empty aircraft seat (or for that matter, an
empty theatre seat or unoccupied hotel room) at any point of time is a permanent loss of revenue
because there cannot be any inventorising of an empty seat and is a permanent loss of
revenue. Pricing is often subject to intense competitive dynamics and the costs are
largely inflexible and lumpy, with fuel costs (uncontrollable) being a significant
element of cost. Hence, the cost structure, the revenue side as well as the capital
structure, all represent challenges and beyond one's control. This is what makes airlines
such a terrible business. In general, it is really hard to make profits in this business, while
economic profits being a sheer luxury. High capital intensity raises operating
leverage of a business. The capital intensity can stem from two elements: the need
for fixed assets (fixed capital) and/or working capital (circulating capital). A business
which requires both high fixed capital as well as high circulating capital is a business
with a rather unfavorable capital intensity profile. In some cases, high fixed capital
intensity may be compensated by light working capital intensity and vice versa.
But if one has to tolerate capital intensity for any one of the two elements, then it is
better to have capital intensity due to working capital rather than due to fixed assets.
That is because, as discussed previously, capex is upfront for uncertain possible
cash inflows tomorrow. And given the rigidity of the fixed capital, it becomes difficult
to maneuver or modify the fixed capital intensity with the change in the business
conditions. [Bharat shah]
Capital-intensive industries outside the utility sector scare me more. We get decent
returns on equity. You wont get rich, but you wont go broke either. You are better off in
businesses that are not capital intensive. [Source http://buffettfaq.com/#b17]
We've always considered businesses requiring enormous amounts of capital for fixed
assets, especially when they're economically sensitive, to be at a big disadvantage.
Donald Yacktman, Yacktman Asset Management [The Art of Value Investing]
Commodity business + Capital intensive

The textile industry illustrates in textbook style how producers of relatively undifferentiated goods
in capital intensive businesses must earn inadequate returns except under conditions of tight
supply or real shortage. As long as excess productive capacity exists, prices tend to reflect direct
19
operating costs rather than capital employed. Such a supply-excess condition appears likely to
prevail most of the time in the textile industry, and our expectations are for profits of relatively
modest amounts in relation to capital.
Buffett, Warren (2013-04-25). Berkshire Hathaway Letters to Shareholders (Kindle Locations
1260-1264). Max Olson. Kindle Edition.
Exception: Wonderla, heavy capex but not that economic sensitive and margins are
high
Too much equity [PE] or debt chasing the same industry
Ignoring interdependence of Value Chain
The sequence of activities your company performs to design, produce, sell, deliver, and
support its products is called the value chain. In turn, your value chain is part of a larger
value system. The value chain focuses managers on the specific activities that generate
cost and create value for buyers.
There are also activity choices to be made looking downstream in the value system. In
thinking about your value chain, then, its important to see how your activities have
points of connection with those of your suppliers, channels, and
A second major consequence of value chain thinking is that it forces you to look beyond
the boundaries of your own organization and its activities and to see that you are part of
a larger value system involving other players.
And everyone in the value system had better understand the role they play in the larger
process of value creation, even when they are removed by one or two steps from the
ultimate end user.
[Source Understanding Michael Porter: The Essential Guide to Competition and Strategy ]
Seek Protection from Nature, more so when funded by debt
One of my key learnings as a value investor is that the closer you get to nature, the
more youre playing with fire. By nature I mean anything you get out of the ground
metals, minerals, oil whatever. These economics of things is so damn hard to predict
accurately and these things experience just too much price volatility. Take a look at this
chart which depicts the long-term movement of the Bloomberg Commodity Index which
tracks the prices of 20 commodities including Aluminium, Crude Oil, Copper, Corn,
Cotton, Gold, Natural Gas, Nickel, Silver, Sugar and Zinc.
That index is now back to where it was in 1991. Crude oil alone has gone from less than
$10 a barrel to $140 a barrel and now at less than $30 a barrel. When it was at $140,
people were talking peak oil and now when its at below $30, the world is awash in oil.
In terms of probability, the problem with such industries is to do with ranges of outcome.
They become very wide. Indeed, they become so wide, that even trying to value
20
businesses in such industries should count as speculative. But when people have
elaborate excel models and minds which tend to overweight recent experiences, they
end up extrapolating near term trends. If prices are going up, they assume they will stay
up and when they are going down they assume that they will keep going down even
more. Charlie Munger calls this type of blind extrapolation not just slightly stupid, but
massively stupid.
Investors should recognise that some things, by their very nature, are just too hard to
predict. The value of ONGC at at $30 per barrel oil price is going to be vastly different
from its value at $140 a barrel oil price. But people who are hell bent on trying to value
ONCG (or Cairn or any oil company for that matter) try to deal with the massive
uncertainty by using scenario analysis. They assign subjective probabilities to
pessimistic scenario like a $30 per barrel, optimistic ones at say $140 per barrel and
many other scenarios in between and then compute weighted average value. Thats the
functional equivalent that 6 ft. tall statistician who drowned in water which was, on
average only 4 ft. deep. He forgot that range of depth was between 1 ft and 7 ft.
When oil is at $30, its hard to visualize that it could go to $140 or $200 or $500. But who
the hell can knowwhere it will go? Similarly, when it was at $140, it was hard to visualise
that it could drop to $30 or $10 or $5.
The consequences of being wrong with ones predictions in situations where the ranges
of outcome are likely to be very wide and thats certainly the case when one is
dealing with natural resources can be devastating.
The problem is further compounded by financial leverage. Many of the businesses in
such industries take on enormous amounts of debt for expansion during good times.
Unfortunately, such times never last. And when the tide turns, many participants are
found to be swimming naked.
The big lesson for investors here is that when you combine high volatility inherently
present in a business model with financial leverage, you get extreme volatility in equity
valuations. During good times these businesses may have reasonably strong balance
sheets, and excellent profit margins. In bad times, they end up with huge debt and
evaporation of profits. This swing from riches to rags is also reflected in their equity
market values as the chart below shows. [Prof Sanjay Bakshi]
Direct or indirect strong commodity link is an implicit bet on the commodity price
Activity levels for a company selling into the oil and gas industry will look very different if the new
normal price for crude oil is $ 50 per barrel versus $ 100 per barrel. When buying companies with
a strong commodity link, direct or indirect, an investor makes an implicit bet on the commodity
price. We urge caution. History teaches that it is easy to have an intelligent opinion about
commodity prices, but tough to get it right. [Quality Investing]
The least attractive form of cyclicality effect occurs in pure supply-demand industries, such as steel
21
making or offshore drilling. In these industries, products tend to be uniform and significant capital
outlays are necessary for production. When the economy shifts, as it inevitably does, demand
drops and the costs of over-capacity come due. As demand drops, prices fall and profits suffer. In
such an environment, it is virtually impossible to plot the future price path, to forecast its low-point
or predict the duration of the downturn. In theory, economists marginal cost curves should
illuminate the break points where participants will stop producing and stability will return. In
practice, however, producers do not conform to economic models, as managers pursue agendas
to maintain production despite the directives of marginal cost theory.
In supply-demand industries, some companies may command competitive advantages by being
low-cost producers. But the economic value of such a trait is hard to assess when prices are next
to impossible to predict. An oil company that can extract oil at a cost of $ 20 per barrel may have
a cost competitive advantage. However, determining the value of the cash flow of such an
advantage depends entirely on whether the long-term oil price is $ 40 or $ 100 per barrel. When
buying companies with a strong commodity link, direct or indirect, an investor makes an implicit
bet on the commodity price. We urge caution. History teaches that it is easy to have an intelligent
opinion about commodity prices, but tough to get it right.
In general, I'm uncomfortable with companies that are vulnerable to more than one of those kinds
of leverage going against them at the same time. A cyclical business that has a lot of fixed costs,
for example, should not have a lot of financial leverage or be too levered to one geography or
industry. If things go the wrong way, management has its hands tied in trying to get out of trouble.
This is a big reason we rarely find opportunity in more commodity-type businesses. David
Herro, Harris Associates [The Art of Value Investing]
What happened when Warren Buffet took call on oil prices?
In 2002 and 2003 Berkshire bought 1.3% of PetroChina for $ 488 million, a price that
valued the entire business at about $ 37 billion. Charlie and I felt that the company was
worth about $ 100 billion. By 2007, two factors had materially increased its value: The
price of oil had climbed significantly, and PetroChinas management had done a great
job in building oil and gas reserves. In the second half of last year, the market value of
the company rose to $ 275 billion, about what we thought it was worth compared to
other giant oil companies. So we sold our holdings for $ 4 billion. The price of
PetroChina stock fell off a cliff at the very end of 2007 and has never returned to its bullmarket levels so Buffett made a good sale. On the other hand, he piled money into
another oil company, ConocoPhillips, in 2007 and 2008 with terrible timing, he said
soon after, because oil prices promptly fell. In 2009 and 2010 Berkshire sold about twothirds of its ConocoPhillips position. The losses Berkshire took on that oil
investment roughly balanced what it had made on PetroChina. [Source:
Tap Dancing to work]
Exception cement stocks
For example, cement is basically a domestic industry, largely immune from
competition of imports, given the rather high transport costs. Because of the
consolidation of the industry, among limited players over the last decade or so, it has
22
acquired pricing power. Given also the fact that broad demand-supply equation is
favorable, cost warriors and efficient players have now healthy debt- free balance
sheets and respectable and consistent capital efficiency. [Bharat Shah]
Exception: Cyclical companies that are well capitalized + Dont lose money at bottom of the cycle
We're far more interested in cyclical companies that are well capitalized, that don't lose money at
the bottom of the cycle, and whose peaks and troughs are both higher over time. We'd be less
apt to buy into something like a capital-intensive pulp and paper manufacturer, which bleeds
money at the trough and, when they do generate some cash flow, needs to spend much of it on
new or upgraded plant and equipment. Charles de Lardemelle, International Value Advisers
[The Art of Value Investing]
Prefer cyclical companies that act counter-cyclical
Cyclical industries don't scare us if we understand the long-term supply and demand dynamics of
the industry and believe that the company we're interested in is on the right side of that. We
think, for instance, that insurance is a lousy business. There's way too much capital, too little
differentiation and way too many managements doing the same dumb things. That's all
contributed to there being a generally soft pricing market for six or seven years. That said, we're
happy to own insurance companies that don't think like everyone else and zig when the others
zag. Steve Morrow, NewSouth Capital [The Art of Value Investing]
23
Investor
Stay Simple, Stay Humble
https://medium.com/@timhanso/the-humility-curve-42c4152a5054#.a7wnoqdrb
Too many moving variables
One mistake value investors can make is to focus too literally on the absolute difference
between an estimate of intrinsic value and the stock price as the valuation cushion. If
the range of potential outcomes is very wide , you may have much less of a cushion
than you think. One big reason we focus on better-quality businesses with great balance
sheets is that the variability in outcomes and therefore the risk of blowing through the
valuation cushion is lower. Dan O'Keefe, Artisan Partners
Ability to handle volatility through financial strength low or no debt and significant disposable
income preventing the need to liquidate portfolio during inappropriate times.
[Prof Sanjay Bakshi, What is Staying Power]
24
A very long-term view about investing.

[Prof Sanjay Bakshi, What is Staying Power]
Examples of failures
Failure to scale up
Bildner, Speciality Food store [Scalability is not easy]
Selling sandwiches and prepared hot foods
As per Peter Lynch, he found them to be clean, efficient and full of satisfied
customers.
Instead of adding debt, company took decision to took new stores on leases.
Soon after this sale of stock, Bildners opened two new outlets in a couple of
Boston department stores, and these flopped. Then it opened three new outlets
in the center of Manhattan, and these got killed by the delis.
One or two mistakes at a time might not have been so damaging, but instead of
moving cautiously, Bildners suffered multiple and simultaneous failures.
Its too bad, because I thought Bildners could have been the next Taco Bell.
Indian Companies to watch out for
Lovable Lingerie 2006-12 sales increased from 30 to 140crs 2012-16 sales
increased from 140 to 200crs.
Kewal Kiran 2006-12 sales increased from 85 to 320crs. 2012 -16 320 to
452crs
Agro Tech Foods 2009-16: Sales in 700-800crs range and profits 20-40crs
range.
Vaibhav Global
Irrational competitors. EMIs for product costing less than 20USD
Execution problem Failed implementation of new sales software, call centre
relocation to Mexico.
Entering items like Home Dcor, Luxury watches and trying to compete with
biggies like Amzaon.com rather than its niche of specialty jewelry
[Not very sure of the above reasons, not tracked closely]
Saipem, an offshore oil field company

Some patterns [Mistaking cyclical growth as structural growth + cyclicality of demand of
customers + price of end product fluctuates + depends on capex decisions of customers
]
For a decade double digit earnings growth and high returns on capital
25
By end of 2012, US share oil emerged as a cheaper option. Industry returns

faltered.
2012-2015 lost 80% of market cap.
Underappreciated extremely protracted nature of cycles in natural resource
company.
A more comprehensive analysis extending back to the early 1980s, the most
recent analogous period, would have highlighted how the oil and gas industry
was engaged in a historically massive capacity build-out program. The stimulus
was historically high oil prices; in inflation-adjusted terms, the price of oil had only
been higher on one occasion in the preceding 100 years.
This example offers numerous lessons about cyclicality. For one, cycles can vary
enormously in length: for some industries, ten or even 20 years of history
provides insufficient context. To gauge this, and help improve the understanding
of a cyclical company through the cycle, it is important to analyze the information
available as far back as possible, preferably several decades.
Oversupply arrests growth for any cyclical company [Source Quality Investing]
Indian example - Aban Ofshsore

Some patterns
Provides rigs for deep sea drilling. Post decline in crude oil prices exploration
becomes unviable.
Price of end product fluctuates widely + Debt funded acquisitions
High capital intensive + cyclicality in demand of end customers
Depends on capex decisions of customers
Indian Example - Gujarat Rubber Reclaim

Some patterns
Pending
Suzlon [Dependence on government + debt fueled acquisition]
Some patterns
Indian & Majority of European governments removed tax incentives for

accelerated depreciation which led to slump in domestic business.
Debt fueled acquisitions.
German laws prohibit merging cash rich RePower with itself
Quality problem in blades supplied to western world.
Decline in oil prices [Not sure, need to confirm]
26
Indian Infrastructure industry, Mining, Telecom, Power, and the ancillary industries depended on
these industry
Gammon India
Some patterns
Dependence on government [Land clearance,

High debt + cyclical industry
IVRCL
Some patterns
6,000crs stuck with government on various disputes [Dependence on

government]
High debt + cyclical industry
L1 bidding [Not sure]
Jain irrigation [post 2007 period]

Delay in receiving subsidy from government.
Company took debt to finance working capital.
Debt funded acquisitions
Noida Toll Bridge [Change in favorable contract by govt.]
Hugely favorable contract ultimately changed by government
Cabbage Patch Kids [Consumer fads/Fashion risk, Threat of Substitute]
Wholesale revenues from Cabbage Patch Kids dolls, launched by Coleco in 1983,
soared to $ 550 million in 1984, and total merchandise sales brought a multiple of that.
A successful pop music record was released and the characters adorned products from
clothing to breakfast cereal. The dolls were ubiquitous. By 1987, however, the fad was
over, and wholesale revenue dropped by nearly 75%, a collapse that contributed to
Colecos bankruptcy. [Quality Investing]
Dental Implant Nobel Biocare [Good enough goods + Influential middlemen +Performance
oversupply, Threat of Substitutes]
Nobel sales grew at 20% CAGR between 2003-2007
Gross margins above 80% high returns on capital
Perception was there is reasonable entry barriers in terms of technology and
distribution network.
By 2007-08, category matured. Competitors started offering implants at lower
price to dentist. Dentist started using cheaper alternative with good enough
quality and which was offering them higher margins. Patients were relying on
influential middlemen [doctors]
Pre-tax earnings for 2014 only 33% of what delivered in 2006.
27
Indian company to watch out for: Plywood Industry

Influential middlemen [seller and carpenter]
Simple technology most of the unbranded plywood at par with branded one.
[Good enough goods]
Win win situation for everyone [Dealer gets higher margin and longer credit
period, carpenter gets commission from seller and customer saves 10-20%]
Performance oversupply example: Intuit accounting software [Threat of Substitutes]
Less well known is Intuits commanding 70 percent share of the North American small
business accounting software market. 6 Intuit captured that share as a late entrant when
it launched Quickbooks, a product based on three simple insights. First, previously
available small business accounting packages had been created under the close
guidance of certified public accountants and required users to have a basic knowledge of
accounting (debits and credits, assets and liabilities, and so on) and to make every journal
entry twice (thus providing an audit trail for each transaction). Second, most existing
packages offered a comprehensive and sophisticated array of reports and analyses, an
array that grew ever more complicated and specialized with each new release as
developers sought to differentiate their products by offering greater functionality. And
third, 85 percent of all companies in the United States were too small to employ an
accountant: The books were kept by the proprietors or by family members, who had no
need for or understanding of most of the entries and reports available from
mainstream accounting software. They did not know what an audit trail was,
let alone sense a need to use one. Scott Cook, Intuits founder, surmised that
most of these small companies were run by proprietors who relied more on their
intuition and direct knowledge of the business than on the information contained in
accounting reports. In other words, Cook decided that the makers of accounting software
for small businesses had overshot the functionality required by that market, thus creating
an opportunity for a disruptive software technology that provided adequate, not superior
functionality and was simple and more convenient to use. Intuits disruptive Quickbooks
changed the basis of product competition from functionality to convenience and captured
70 percent of its market within two years of its introduction. 7 In fact, by 1995 Quickbooks
accounted for a larger share of Intuits revenues than did Quicken. The response of
established makers of small business accounting software to Intuits invasion, quite
predictably, has been to move upmarket, continuing to release packages loaded with
greater functionality; these focus on specific market subsegments, targeted at
sophisticated users of information systems at loftier tiers of the market. Of the three
leading suppliers of small business accounting software (each of which claimed about 30
percent of the market in 1992), one has disappeared and one is languishing. The third
has introduced a simplified product to counter the success of Quickbooks, but it has
claimed only a tiny portion of the market.
Tata Steel [Balance Sheet risk]
Some patterns
Seek protection from nature [Crashing of steel prices]

28
Debt fueled acquisition

Cheap Chinese steel dumped across the globe [Competition from a low cost country]
Electrosteel
Some patterns
Seek protection from nature [Crashing of steel prices ]

Dependence on government [Bokaro project involving total outlay of more than 11,000
crores faced severe delays as government cancelled Chinese workers VISA]
Coal mine cancelled [Dependence on government]
Debt funded expansion in a commodity industry
Jain irrigation [Early 1990s]

Venturing into new fields without any expertise.
Debt funded diversification.
Depended on access to capital markets for funding its expansion
Ignoring interdependence of Value Chain
Ford lost market share to GM by failing to see importance of credit to customers
In the 1920s, when cars were still rich mens toys, General Motors and other
automakers started their own consumer finance divisions to help customers buy cars on
credit. Henry Ford, a man of strong convictions, believed that credit was immoral. He
refused to follow GMs lead. By 1930, 75 percent of cars and trucks were bought on
time, and Fords once dominant market share had plummeted.
Nomacorc captured 20% market share as traditional cork makers for wine bottles ignored end
consumer
Most wine drinkers know how unpleasant it can be to uncork a nice bottle of wine, pour
it for a guest, and then discover that its corkythat is, the taste has been ruined by a
problem known as cork taint. By the 1990s, the problem reached a tipping point for wine
makers and sellers. They wanted cork makers to fix it. You dont want a cheap,
commodity-like component to ruin the value of an expensive product. Cork, most of
which comes from trees in Portugal and other Mediterranean countries, has enjoyed a
near monopoly on wine closures not just for decades, but for centuries. No surprise,
then, that the cork makers were slow to respond. Their skill lay in harvesting cork from
the outer bark of cork oaks without damaging the trees. They were hand workers
basically farmers, not chemists. This created an opportunity for plastics makers such as
Nomacorc to step into the breech. Nomacorcs value chain made it relatively easy for it
to undertake research into the chemistry of wine taint, and to solve the problem. While
the traditional cork makers were stuck in an older mind-set (were in the cork
business), the plastics makers could see how to become part of a larger value-creating
29
process. By 2009, Nomacorcs automated North Carolina factory was churning out
close to 160 million plastic stoppers a month, and synthetic corks had captured 20
percent of the market.
Valeant Pharmaceuticals
What was being done by these pharmaceutical companies was that they would acquire
small companies selling medicines for rare but critical diseases with a limited number of
suppliers of the medicines. Post-acquisition, they would regularly ramp up the prices of
medicines, and given the backlog with the US Food and Drug Administration (USFDA) for
approving new generic suppliers, they would make outsize profits. To illustrate, the
price of one medicine, Daraprim, was jacked up from $13.50 per tablet to $750 per
tablet, virtually overnighta price increase of more than 55 times. Just to clarify, this
was not a new drug, no new research was carried out, and there was no cost increase in
terms of raw material prices or manufacturing process, and so on. [Source: What the
public wants, the public will get, Rajeev Thakkar]
Enron, India
The company thought that it was being smart in getting a sweet deal by spending
money to educate politicians and bureaucrats in India. It later on realised that a
contract is worthwhile only if the counter parties are willing to honour it, if the courts
respect the agreement and if the general public supports it.
Enron realised that the customers that had signed the contract were just not able to
afford the power that it produced and the terms of the contract were not honoured.
Appendix
Success = Strategy + Execution [which depends on management personality] + Luck + avoiding
technology disruption
According to Michael Porter of Harvard Business School, company performance is
driven by two things: strategy and execution. Strategy is about performing different
activities from those of rival companies, or performing similar activities in different ways.
A strategy is not a goal or an objective or a target. Its not a vision or mission or a
statement of purpose. Its about being different from rivals in some important way. In
turn, execution is all about carrying out those choices. It refers to the way that people,
working together in an organizational setting, mobilize resources to deliver on the
strategy. Building high-quality products, providing customer service, managing working
capital, developing and deploying talent these usually arent matters of strategy
because almost every company wants to do these things well. Rather, these things are
the stuff of day-to-day management. Theyre all about effective operations.
All companies face a handful of basic strategic choices. In what products and markets
shall we compete? What activities shall we perform and what shall we decide to leave
to suppliers or partners? How shall we position ourselves against our rivals shall we
30
take a premium position, or shall we be known for low cost? These are choices in the
sense that a company cant hope to be all things to all customers at all times, but has to
choose to compete in this product line and not in that one; to enter this market and stay
out of that one; to perform these activities but not those; and to position itself relative to
competitors in this way but not that one. These sorts of choices arent bland statements
of aspiration, but fundamental decisions that set a company apart from its rivals. And
choosing to be different implies risk.
There are several reasons why strategic decisions are so uncertain. A first reason has
to do with customers. Will customers embrace or reject a new product or service? How
much will they be willing to pay? Its hard to tell for sure.
Sun Records producer, once cautioned: Any time you think you know what the publics
going to want, thats when you know youre looking at a damn fool when youre looking
in the mirror. Market reaction is always uncertain, and smart strategists know it. A
second source of risk has to do with competitors.
A third source of risk comes from technological change. Some industries are relatively
stable, with products that dont change much and customer demand that remains
steady for long periods of time. If youre Kelloggs and you sell cornflakes, you might be
able to crank out a steady profit year after year. People still need to eat breakfast, no
one has invented a much better cornflake, and you have a well-known brand, all of
which may translate into steady revenues and profits (at least until generic cornflakes
and private labels erode market share and margins or until large retailers squeeze our
profits nothing is forever, as Schumpeter would tell us). But in other industries,
technology changes rapidly and strategic choices can come one after another with lifeand-death consequences. In his groundbreaking research, Clayton Christensen at
Harvard Business School showed that in a wide range of industries, from earthmoving
equipment to disk drives to steel, successful companies were repeatedly dislodged by
new technologies. They didnt fail because they were badly managed the problem
was more insidious than that. Rather, it was because they kept doing everything right
they focused on the needs of their customers and invested in new products that had a
high likelihood of success that they became vulnerable to new technologies. These
so-called disruptive technologies at first didnt look attractive to established players
they didnt meet the needs of existing customers and didnt promise substantial sales
and therefore tended to be ignored, yet they improved over time and eventually
displaced the existing technology, spelling disaster for market leaders. It is, after all,
very hard to know which new technologies will lead nowhere and can be safely ignored,
and which will transform the industry and pose a mortal threat. Add together these three
factors uncertain customer demand, unpredictable competitors, and changing
technology and it becomes clear why strategic choice is inherently risky.
Jim Collins expressed surprise that the eleven Great companies came from ordinary,
unspectacular industries like consumer retailing, consumer products, financial services,
and steel? He offered a powerful implication: You dont have to be a glossy high-tech or
31
biotech company to become Great. If these run-of-the-mill companies can become

Great, well, then so can you! But I suspect a different interpretation is more accurate.
These industries can be described as dowdy, but a better word might be stable. They
were less subject to radical changes in technology, were less susceptible to shifts in
customer demand, and may have had less intense competition. All of which meant that
companies in these industries had a better chance of racking up consistent
performance, year after year, than did companies in more turbulent industries.
Strategic choice depends on customer preferences and the actions of competitors and
the prospects of some new technology all of which are in the messy world outside.
Strategic leadership is about making choices, under uncertainty, that have the best
chance to raise the probabilities of success, while never imagining that success can be
predictably achieved. Strategy is about choice, and choices involve risk.
If the criterion is fifteen consecutive years of high performance, it may be more
accurate to say that only companies in stable industries are likely to achieve Greatness.
But chance does play a role, and the difference between a brilliant visionary and a
foolish gambler is usually inferred after the fact, an attribution based on outcomes. The
fact is, strategic choices always involve risk. The task of strategic leadership is to gather
appropriate information and evaluate it thoughtfully, then make choices that, while risky,
provide the best chances for success in a competitive industry setting.
And the Uncertainties of Execution In recent years, increasing attention has been
paid to the second pillar of company performance, execution. A few prominent business
leaders have trumpeted its importance. Its absence is the single biggest obstacle to
success and the cause of the disappointments that are mistakenly attributed to other
causes. No strategy can deliver results unless its converted into specific actions and
those specific actions are the stuff of execution.
Whenever someone says, We have the right strategy, we just need to execute better, I
make sure to take an extra-close look at the strategy.
Wise managers know that business is about finding ways to improve the odds of
success but never imagine that success is certain. If a company makes strategic
choices that are shrewd, works hard to operate effectively, and is favored by Lady Luck,
it may put some distance between itself and its rivals, at least for a time. [Halo Effect]
Look beyond measurable performance in terms of ROE and growth to judge quality of company
and quality of management:
Rather than assume that a successful company has superb customer orientation
and excellent execution skills, or that a struggling company must have displayed
complacency or weak execution, it is important to seek independent evidence.
We need to ask: If we didnt know how the company was performing, what would
we think about its culture, execution, or customer orientation? As long as our
32
judgments are merely attributions reflecting a companys performance, our data will be
biased, our logic circular, and our conclusions doubtful.
We may look at successful companies and applaud them for what seem, in retrospect,
to have been brilliant decisions, but we forget that at the time those decisions were
made, they were controversial and risky. McDonalds bet on franchising looks smart
today, but in the 1950s it was a leap in the dark. Dells strategy of selling direct now
seems brilliant but was attempted only after multiple failures with conventional channels.
We routinely trust financial performance figures. And its natural that on the basis
of this performance data, people make attributions about other things that are
less tangible and objective. All of which helps explain what we saw at Cisco and ABB.
As long as Cisco was growing and profitable and setting records for its share price,
managers and journalists and professors inferred that it had a wonderful ability to listen
to its customers, a cohesive corporate culture, and a brilliant strategy. And when the
bubble burst, observers were quick to make the opposite attribution. It all made sense. It
told a coherent story. Same for ABB, where rising sales and profits led to favorable
evaluations of its organization structure, its risk-taking culture, and most clearly the man
at the top and then to unfavorable evaluations when performance fell. Journalistic
hyperbole? To some extent, sure. But more importantly, a natural human tendency to
make attributions based on cues that we think are reliable.
We have almost no ability to evaluate whether a company has a performancebased culture or a fast, flexible, flat organization without knowing something
about its performance. The ways we describe, mythologize, and sometimes speak
rhapsodically about company culture and organization are almost entirely the result of
performance.
Management should be judged independent of financial performance: For all the
books written about leadership, most people dont recognize good leadership
when they see it unless they also have clues about company performance from
other things that can be assessed more clearly namely, financial performance.
And once they have evidence that a company is performing well, they confidently make
attributions about a companys leadership, as well as its culture, its customer focus, and
the quality of its people.
Cisco was rated high for lots of other things, too: quality of management,
innovativeness, quality of people, and more. When the tech bubble burst and Ciscos
stock fell, in 2001, Ciscos rating as an investment value quite naturally fell. But with the
Halo of financial performance tarnished, its ratings fell across the boards. Cisco was
now less admired for innovativeness, for people, the whole works. Its overall rating
dropped to number fifteen in 2001, then twenty-two in 2002 and twenty-eight in 2003.
Fortunes survey isnt the only one to be undermined by the Halo Effect.
But Bertrand and Schoar knew better than to gather cartons of magazine articles or to
ask managers to rate the style of their chief executives methods that would do little
33
more than capture Halos. Instead, they defined managerial style in terms of two
specific policies: investment policies (captured by levels of capital expenditures and
administrative costs, and the frequency of mergers and acquisitions) and financial
policies (captured by levels of debt and of dividends). These policies were objective and
measurable, not ambiguous and hard to define. Next, they gathered data from audited
financial statements so there could be little chance of a Halo Effect. As additional steps,
they controlled for a number of other variables, and they also looked at the actions of
specific managers over time, examining their tenure at more than one company. This
was good, solid social science research. And the results? Bertrand and Schoar found
that individual managers indeed have preferred personal styles when it comes to
investment and financial policies, and that these preferences explain about 4 percent of
the variance of company performance. In other words, after controlling for several other
factors, the impact of a managers personal style on company performance was about 4
percent.
If success or failure measured from looking at performance, results are mostly flawed:
In a series of experiments about group performance, UC Berkeley professor Barry Staw
(then at the University of Illinois) showed that members attribute one set of
characteristics to groups they believe are high performers, and a very different set of
characteristics to groups they believe are low performers. When told their group had
performed well, members described it as having been more cohesive, with better
communication, and more open to change; when told it had performed poorly, they
remembered the opposite. In fact, the groups had done just about as wellthe only
difference was what Staw had told them about their performance. Similarly, in a series
of studies about leadership, James Meindl and his colleagues found that the words
used to describe leaders were highly dependent on the performance of the company. In
fact, they concluded that there was no adequate theory of leadership in the absence of
knowledge about company performance. A successful company with a strong record of
performance? The leader appears to be visionary, charismatic, with strong
communication skills. A company that has suffered a downturn? The same leader
appears to be hesitant, misguided, or even arrogant.
As long as people are asked to assess companies when they already have an opinion
about its performance, their evaluations are likely to be biasedand their resulting
findings of questionable value. [Halo Effect]
Alice on How Warren buffet gives imp. to patterns
He is a great synthesizer and especially strong at pattern recognition. Hes also
able to follow what I would call it decision trees and figure out probabilities in his
head at an astonishing pace.
History was one of Warrens best subjects even when he was very young (in
school). He has a liking for it. But at the same time pattern recognition is one of
his primary skills and perhaps his greatest skill. So in terms of data points, unlike
34
many people who learn by seeking information on an as-needed basis, Warren is

always looking for fuel for pattern recognition before he needs it
Take this example. If you look at the dotcom stocks, the meta-message of that
era was world-changing innovation. He went back and looked for more patterns
of history when there was a similar meta-message, great bursts of technological
innovation in canals, airplanes, steamboats, automobiles, television, and radio.
Then he looked for sub-patterns and asked what the outcome was in terms of
financial results.
With the dotcoms, people were looking to see what was different and unique
about them. Warren is always thinking whats the same between this specific
situation and every other situation.
That is the nature of pattern recognition, asking What can I infer about this
situation based on similarities to what I already know and trust that I
understand? There is less emphasis on trying to reason out things on the basis
that they are special because they are unique, which in a financial context is
perhaps the definition of a speculation. (Warren is not averse to speculation, by
the way, as long as its what he calls intelligent speculation, meaning hes got
long odds in his favor.) But pattern recognition is his default way of thinking. It
creates an impulse always to connect new knowledge to old and to primarily be
interested in new knowledge that genuinely builds on the old
Pattern recognition skills are worthless if you invent patterns that arent there. My
one really difficult experience as an analyst was at PaineWebber during the
dotcom bubble. It was like bullishness was a drug poured into the NYC water
supply. Everyone believed. The idea that investment banking pressure was
solely responsible for the Internet bubble has been overplayed. We were a
wirehouse, and we drank the Kool-Aid just like everybody else
Warren Buffet AGM 2016 on Pattern Recognition

Pattern recognition gets important in evaluating humans and businesses. There are
certain things in business and securities markets we have seen over and over and that
frequently come to a bad end but frequently look extremely good in the short term.
There were patterns at Valeant that really should have been picked up on and that have
been very painful to the people of Sequoia.
How to think about valuation of cyclical companies
When to buy cyclical companies
The first-tier companies, as they were constituted in their heyday, were overwhelmingly companies
that were believed to be either completely or highly resistant to purely cyclical influences.
Tremendous premiums were paid for companies with a past record of improved earnings in every
year, if it was believed that this trend would continue in the future. Does it make sense to pay this
kind of premium to avoid the probability of holding an otherwise outstanding stock through an
occasional poor year? I do not believe it makes any sense at all, provided one safeguard is present.
35
The more cyclical company must be a sufficiently low-cost operator so that, at the bottom
of the down side of a cycle, there are sufficient current earnings to finance the needs of the
company, including maintaining the existing dividend. There is no inherent reason why over
a period of years such a company should not be a holding fully as attractive to a conservative
investor as a noncyclical company would be, assuming the two to be comparable in all other ways.
Because this matter is so often misunderstood, let us take a theoretical example of two highly
attractive companies. Each will, for the next ten years, increase annual earnings on an average of
25 cents per share, but company A is cyclical and company B is not. Let us make two further
assumptions. Company A, although earning an average of 40 cents per share less than company
B during this ten-year period, is nevertheless just as capable as company B of financing its
growth and maintaining its dividend from internally generated funds. Also, and even more
important, at the end of the ten-year period the outlook for both companies is equally good
for the time ahead. In that event there is no reason why company A would not be a thoroughly
worthwhile investment vehicle that should sell at just about the same ratio to its average earnings
as company B. Yet, as the financial community operated under the two-tier market, company A
consistently sold at a very much lower price-earnings ratio. This extreme stress on the
importance of increased earnings every year is all the more illogical because, under todays
economics, the year is becoming less and less significant as the most appropriate span of time in
which to measure results.
Common Stocks and Uncommon Profits, Paths to Wealth through Common Stocks, Conservative
Investors ... and Developing an Investment Philosophy (Kindle Locations 8818-8823).
Jain irrigation [Early 1990s]
By early 1990s, we had firmly established ourselves in India and abroad. We had grown
to be a reputed business house with sound financials, a strong ethical base, a spotless
track record of best practices in business and reasonably good financial surpluses. For
once, I would not mind using the word gloating to describe our mentality in those days.
We were self-assured and sure-footed, and this resulted in overconfidence. We thought
that we were capable of much more. I thought that all that we had were PVC pipes and
drip irrigation under our belts. Both these product lines were broadly concerned with
conveyance and distribution of water. Was this not a very narrow band of operation for
us? Were we not putting all our eggs in two baskets? Did it not imply that our business
was highly dependent on agriculture, which in itself, was dependent on a host of erratic
and unpredictable aspects like the monsoons? These questions and thoughts,
combined with our confidence, or overconfidence, led us to the conviction that
diversification was not only a choice but also a necessity. Hence, we chalked out an
ambitious diversification plan, and we were rather in a hurry to put it in place.
We included such diverse businesses as advertising, media, IT, even
telecommunications and stone quarrying. These were not only highly unrelated areas to
each other, but also totally alien to us as businessmen and entrepreneurs.
Look at the diversification profile. Calling it diversified would be a misnomer. It was more
like an oddly assorted menu of strange items, basically incompatible with each other.
36
From food processing to animation to quarrying, we wanted to be everywhere. And we

were in a hurry. The combination almost proved to be fatal for our corporate existence.
During the implementation stage, we had to re-visit some of the projects based on
technical advice, thereby increasing our commitment by more than 100 crore, and
taking it to 375 crore. In the interim, there was an unprecedented correction in the
capital market. India had suddenly lost its shine. The capital market dried-up and due to
the overall adverse economic conditions, lenders went on the back-foot and wanted
recoveries of their loans.Read more at location 244 Delete this highlight
The working capital of the existing business had to be used to support these new
projects and the Company faced a severe liquidity crunch. The situation changed from
Best to Worst'. Revenues shrank and losses started mounting-up due to the high
interest burden. The Company got into a vicious cycle where interest was a little less
than 50 per cent of its revenueclearly a sign of an unsustainable operation requiring
massive restructuring. The financial year 1998-99 showed revenue of 244 crore and
interest at 112 crore
The next prime requirement was human talent and skill. Many of the areas in our
diversification blueprint were highly technical or technology-oriented, and we had no
inkling of its technical nitty-gritty. So it was obvious that we would require domain
experts in each field to run the show. In consideration of these limitations, we went
ahead with due diligence and hired the best talent in the industry to lead each activity.
However, a combination of bad judgment, oddity of providence and letdowns by people
whom we trusted, led to ultimate failure of many of these businesses. Bad news was so
frequent and forthcoming in those days, and I vividly remember each one of them, not
because I am bitter about them. No, I am not. But I remember those fateful days
because they taught me some of my lifes most valuable and hardest lessons, and by
using these words I imply that the harder the lesson is, the more valuable it is. The first
casualty was our telecom and technology venture. We simply could not provide effective
leadership for it. The person from whom we had bought this business, and who was to
lead the business, left us midway. Without him, we became directionless and
disoriented, and we could never recover from the blow. The merchant banking business
was led by a very senior professional who was good at marketing but often poor in
documentation and securitization. So the project quickly wobbled off its trajectory and
became unmanageable. The advertising and multimedia ventures were simply too
dynamic for us to handle. In hindsight, I think they were in complete variance with our
business style, and we were inherently incompatible with them. The water-soluble
fertilizers project was a joint venture with a foreign partner, who regressed on the
understanding and did not agree to expand. As a result, he exited and we had to take
over his part of equity. The polystyrene and poly-butylene products could not be
developed because the raw material suppliers discontinued the supplies. We later
learned that they had serious quality problems in their own countries. In the granite37
quarrying venture, the market reality worsened China entered into the fray. Granite
cost, which was 1,650 USD per cubic metre, dropped to 800 USD per cubic metre upon
Chinas market entry.
The fruit processing and onion dehydration activities took far more time to take off than
anticipated. The extended gestation periods not only aggravated the already heavy
interest burden, but also wiped off the break-even projections. In fact, all these failed or
about-to-fail or delayed projects were taking a very heavy toll on the interest front; we
had borrowed money at considerably high interestbetween 16 and 22 per cent. As a
result, we had to take the bitter but inevitable decision to divest from IT and telecom,
advertising and media, merchant banking and stockbroking, and granite quarrying and
processing businesses. However, we decided to retain the tissue culture, and fruit
processing and onion dehydration businesses, primarily because they were in sync with
our focus on agricultural activities. Besides, they made good backward and forward
integration sense, and held promise in the medium to long term. Today, each of these
divisions has matured into profitable and promising activities, adding value to our
agricultural product basket.
However, throughout the process of divestment, we had to divert funds from other
projects to these unviable or slow-starter projects. Even our working capital was
diverted towards paying interests. These diversions adversely affected the performance
and financial health of our existing core businesses. This is how we entered into and got
caught in the vicious circle of a debt trap. Amidst the growing hardship of meeting even
daily expenses, the original strategy of mustering up finances through maiden equity
issues for these activities fell flat on its face. By then, the equity bubble had already
burst, and new issues hardly had any takers. This was, after all, during the turbulent
period of the equity market crisis of late 1990s and early 2000s, when even reputed and
large corporate houses had postponed their equity offerings
Shakespeare said, Dangers come in legion, so as troubles. The option of raising
money through equities having been ruled out, we were horribly cash-strapped 2001,
we were constantly reporting pathetic figures in our balance-sheetsour 2001 annual
report registered sales of just 301 crore and our total debt had burgeoned to 823 crore.
The annual interest burden was at 40 crore, and the losses were 28 crore. With each
passing day, we were being pressed, cajoled, coerced, threatened, and even abused
for our inability to pay our lenders. The banks foreclosed their loans, the private lenders
stopped giving us more funds, and the suppliers withheld fresh deliveries until old dues
were paid. The bad reputation spread like wildfire, and this had a cascading effect on
our share prices. They headed southwards in a tailspin, and touched their face value,
with no returns to offer to investors.
38
Our competitors and cynics took full advantage of the crisis and spread rumors that the
Jains were going under, that they were fleeing the country, that they were filing for
bankruptcy. There was mayhem everywhere, on all fronts. We felt as if we were trapped
in a house on fire, and the fire brigade was not answering our desperate calls! One
thing was certain; we would never go under, or approach the Board of Industrial and
Financial Reconstruction (BIFR) to file for bankruptcy. [Source: The Enlightened
Entrepreneur, Bhavarlal Jain, Jain Irrigation founder & promoter]
Groupon Business Model
It was the fastest growing company ever, and soared from zero to billions in
valuation seemingly overnight
The problem with both of Groupons businesses are the barriers to entry, or lack
thereof. With daily deals, anyone could buy a build your own Groupon software
package (from a company called Groupon Clone, no less) and start selling
coupons with cute emails. In the height of Groupon-mania, many did just that,
driving Groupons customer acquisition costs sky-high and forcing Groupon on
an aggressive acquisition spree to take out regional competitors. At the height of
the boom there were hundreds of daily deals startups. Groupon bought more
than 30 of them. Now Amazon is moving in with its Amazon Local competitor.
And Groupon Goods is already competing with Amazon AMZN 0.66% , and
every other online discounter. [Source: http://fortune.com/2015/03/20/grouponsuccess/]
The businesss most damning mistake was its disproportionate focus on new
customer acquisition, often at the expense of customer retention.
[Source: http://www.businessinsider.com/lessons-from-groupons-businessmodel-2013-3?IR=T]
39
Unprofitable fast growth: Groupon was obsessed with growing as fast and as
big as it possibly could, which resulted in high churn and, as Slates Farhad
Manjoo points out, a business model that is just about anything but
profitable.[Source: http://www.businessinsider.com/lessons-from-grouponsbusiness-model-2013-3?IR=T]
Ignoring existing customers: Oh, and you certainly cant mistreat, abuse, or
ignore your existing customers to the point that very few of them hang around
beyond their first use with your product or service. Doing that simply leads (in a
best case scenario) to treading
water.[Source: http://www.businessinsider.com/lessons-from-groupons-businessmodel-2013-3?IR=T]
Not a win win situation for both Groupon and merchants: "Our findings also
uncovered a number of red flags regarding the industry as a whole: (1) the
relatively low percentages of deal users spending beyond the deal value (35.9%)
and returning for a full-price purchase (19.9%) are symptomatic of a structural
weakness in the daily deal business model."
[Source: http://www.fastcompany.com/3001656/how-groupon-can-save-itself ]
Terms hugely unfavourable to merchants: But as Agrawal described it,

Groupon was riding high because its most important constituencythe small
businesses who slashed their prices to entice Groupons customerswas getting
ripped off. When Groupon runs a deal with a local business, it demands very
unfavorable terms. First, the merchant is asked to substantially reduce his prices.
Then he has to agree to give Groupon a huge splitoften 50 percentof the tiny
amount that he does make from each Groupon sale. For instance, if my fast-food
shack normally sells a burger-and-shake combo for $10, Groupon will want me to
offer it for $5, and then take half of the $5 saleso Ive just sold $10 of
merchandise for $2.50. Its sweet-talking sales staff would also promise that Id
get long-term benefits from the deal. All those Groupon customers would likely
spend more than their Groupon amount, and if they liked my food, theyd keep
coming back even without a deal. Many cash-poor businesses apparently didnt
consider the other possibilitythan in exchange for taking a lump sum now, they
were signing up to give heavily discounted stuff away to deal-hungry
customers who would never step into their stores ever again.
[http://www.slate.com/articles/technology/technology/2012/08/groupon_earnings
_report_the_daily_deals_site_s_crummy_business_model_is_finally_dead_hoor
ay_.2.html]
Sales representative mis-sold the product to merchants exxagerated the

benefits: The trouble isas Agrawal and many small business owners have
documentedtheres ample evidence that Groupons sales reps never
adequately explain the risks, and really exaggerate the rewards, of signing up for
a deal. Because they work on commission, and because Groupon and its
40
investors grew addicted to unsustainable growth rates, the firms sales team
is under enormous pressure to keep signing up more businesses or to make
deals that are even more lopsided in Groupons favor. They often try to get a
huge share of revenuethey even ask for 100 percent of the deal. They dont
give businesses much data on how well similar deals have worked out for other
businesses. (For instance, how many new customers did the businesses get?
How many people spent more than their coupon amountand how much more?)
And they never explain the most important fact about Groupon users: Most of
them are looking for a deal, and theyre unlikely to keep coming back to your
business. http://www.slate.com/articles/technology/technology/2012/08/groupon
_earnings_report_the_daily_deals_site_s_crummy_business_model_is_finally_d
ead_hooray_.2.html
41

Failure Patterns Final by Anil Tulsiram

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Failure Patterns Final by Anil Tulsiram

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Failure Patterns of Companies

Dependence on Government or they play a key role in Industry fortune. .................................................. 5

Cyclicality can change customer behavior in unpredictable ways. ........................................................ 10

Success = Strategy + Execution [which depends on management personality] + Luck + avoiding

Dependence on Government or they play a key role in Industry fortune.

Capital misallocation [i.e new areas where no competitive advantage] + Debt

NOT a Win-Win situation for everyone

Threat of new entrants

Caf Coffee day vs Starbucks

clones, Hagen-Dazs loyalists are by definition going to be harder to find. My

to emerge and subsequently to invade established markets from below. Once

Fashion Risk/ Consumer Fads

Commodity business + Capital intensive

A very long-term view about investing.

Saipem, an offshore oil field company

By end of 2012, US share oil emerged as a cheaper option. Industry returns

Indian example - Aban Ofshsore

Indian Example - Gujarat Rubber Reclaim

Indian & Majority of European governments removed tax incentives for

Dependence on government [Land clearance,

6,000crs stuck with government on various disputes [Dependence on

Jain irrigation [post 2007 period]

Indian company to watch out for: Plywood Industry

Seek protection from nature [Crashing of steel prices]

Anil Tulsiram ContrarianValueEdge.Wordpress.Com

Debt fueled acquisition

Seek protection from nature [Crashing of steel prices ]

Jain irrigation [Early 1990s]

biotech company to become Great. If these run-of-the-mill companies can become

many people who learn by seeking information on an as-needed basis, Warren is

Warren Buffet AGM 2016 on Pattern Recognition

From food processing to animation to quarrying, we wanted to be everywhere. And we

Terms hugely unfavourable to merchants: But as Agrawal described it,

Sales representative mis-sold the product to merchants exxagerated the

Anil Tulsiram ContrarianValueEdge.Wordpress.Com

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