The playful exchange between Elon Musk and Warren Buffett on competitive moats piqued our curiosity in this Industry Focus: Consumer Goods discussion.
Just how hard is it to start a company from scratch and enter the candy business -- as Musk has jokingly threatened to do? We analyze the barriers to thriving within this unique sector as part of our broader look at Musk and Buffet's "competitive moat" debate.
A full transcript follows the video.
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This video was recorded on May 8, 2018.
Vincent Shen: Focusing now on the debate between Musk and Buffett, the questions we're really looking at are, is the moat around candy specifically as wide as Buffett thinks, given his reference to See's Candies? And, can Musk really disrupt the industry enough to overcome that moat, if he were to seriously pursue an opportunity like that. He seemed to be tongue-in-cheek joking earlier, but it'd be interesting to see what somebody like him could come up with, given his track record with PayPal, SpaceX, Tesla.
Let's put the idea of moats to the test: is the candy industry actually that tough to crack? What are your thoughts here, Asit?
Asit Sharma: First of all, I want to just point out to listeners how shrewdly intelligent Warren Buffett is. He's the one who brought up the idea of Musk challenging Berkshire Hathaway's moat in candy. He picked the hardest business with, maybe, the widest moat. I'm going to walk through why I think it's a brilliant example.
Although there may be, for every castle, a knight sitting on a charger pondering on the other side of the moat how to get over that moat, although that may be true, as you point out, Vince, every castle is different, every moat is different. To me, for the sake of definition, let's just say that an established candy company of any size is going to have above what we call the middle market revenue. My round number is, if you can make $20 million annually in revenue or above, that's a good working definition for this argument. Now, candy companies, think about it, they sell one of the cheapest commodities on Earth to one of the most finicky customer groups you can imagine, and that's children. I should say, of all ages. Bear that in mind. It typically takes years, actually decades, to establish a candy brand at scale. I talked about Mondelēz, how they have billions at hand to acquire companies. Only yesterday, they forked over $500 million to acquire Tate's Bake Shop. If you've got those billions, that's great. But if you don't, you have to establish your brand.
Why is it so hard to get to scale in the candy industry? There's a really problematic cycle in candy, and that's the cycle of the fad. A fad can last seven years, it can last ten years, it can last 15 years. The margins in candy are so thin, they don't really justify investing in fads. Let's say Vince and I decide we want to go into business together and form a candy company. We go to Wall Street. Despite all our other fantastic credentials, and what great salesmen we are, [laughs] I think the folks at the other end of the table are going to say, "You know, we don't want to put $30 million into this project, because this brand that you've come up with sounds great, but it may only run for 12 years. And that capital investment isn't worth it for us." Few want to risk millions in capital just to break in via innovation.
Now, the end user, the child or the kid of any age, is really capricious in his or her tastes. So, to break into this business, you have to copy what works. Here's the catch with that: kids like what they like. They don't respond to close copies of products the way adults do. Adults are thinking about how much something costs, about whether the ingredients are wholesome or not. There's a whole range of factors that anyone who's an adult will consider. A kid loves a Snickers bar and doesn't want anything different.
Maybe a little bit later in this segment, Vince, we'll talk about how old some of these candy companies are. It's just another barrier to entry. The suite of candy bars that's in a grocery aisle that you see when you check out is the same as when I was a kid, and I've got a lot of grey on me. I'm sure some of our listeners have an equal amount of grey on them. That hasn't changed, except for some innovation.
Asit Sharma has no position in any of the stocks mentioned. Vincent Shen owns shares of PayPal Holdings. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares), PayPal Holdings, and Tesla. The Motley Fool has a disclosure policy.