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The case study I’m going to discuss in a series of newsletters demonstrates the value of recognising economic franchises formed over time by making a deep impression on the minds of consumers; people form attachments to products they have long been familiar with and have come to trust. Once a brand has this “mind-share” it is difficult for potential rivals to challenge the incumbent. This kind of deep and wide moat around a franchise castle permits exceptional rates of return on equity capital because of the improved pricing power a strong brand brings.
But even strong consumer product companies can become vulnerable. In the late 1980s Gillette was going through such a phase, not on the product attractiveness side but on the financial structure side. It had been attacked by Wall Street raiders, and chose to mollify aggressive shareholders by borrowing a great deal and buying back its own shares. Things went too far, and it started to run out of money and was still a subject of interest to the activists and private equity players. It needed a large cash injection quickly, and it needed a friendly large shareholder who would not sell out to raiders, sack the managers and do untold damage to the long-term health of the businesses. Berkshire Hathaway, Warren Buffett and Charlie Munger fitted the bill. They could come up with $600m almost at the drop of a hat. They would allow the directors to manage in the long-term interests of firm and they would scare off the big beasts of Wall Street.
At first Berkshire bought preferred shares to receive a very generous dividend. But it wasn’t long before the preferreds were converted to common stock, and then the shares moved to a multiple of the $600m put in.
A few years later along came the idea of combining one company holding extraordinarily strong brands, Gillette, with the company holding perhaps the world’s broadest set of strong brands, Proctor and Gamble. Buffett and Munger jumped at the chance of Berkshire being the largest shareholder in the combined company. They could see the quality of the franchises and they could see potential for synergy in linking operations, not least the improved bargaining power vis-à-vis supermarkets.
More recently, when the share price of Proctor and Gamble was high and the directors were willing to part with one of their businesses, Duracell, at what Buffett and Munger thought a bargain price, Berkshire swapped its holding in P&G for 100% of Duracell. This gem came with a cash dowry of $1.8bn. That deal was in 2015 and Duracell is now seen as part of a bigger plan readying Berkshire for the shift from a carbon-powered world to electric power. Duracell sits nicely with Berkshire Hathaway Energy and BYD electric cars and batteries. Even without the potential from collaboration with BHE and BYD, Duracell it has one-quarter of the world’s battery market and a very strong brand.
The creation of Gillette’s economic franchise
A middle-aged travelling salesman, King Gillette, who also filed patents from time to time, thought he could do better than the safety razors on the market in the 1890s. These were of a similar shape to today’s razors but had only one sharp side. Annoyingly, it was necessary to sharpen it on a leather strop or to employ a professional to hone it properly. Also, it w
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