Jeans, moats and Asian expansion

Just because a market exists, doesn't mean a company is equipped to exploit it

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High quality Japanese denim is a niche industry build on the perspiration and dedication of obsessive artisans whose sole focus is in creating products of the highest quality.  Every single pair of denim is created by hand, the fabric woven in mechanical looms, then dyed in a repetitive and time-consuming process using natural dye, before being sewn together with exquisite attention to detail, down to the last rivet and leather patch.

The end result is a Momotaro made in Okayama, Japan which achieved a selling price of US$2000 per pair.

On the other end of the scale, the town of Xintang in Guangzhou, China, manufactures one out of every four pairs of jeans sold worldwide.   The end result is likely to be on the shelves of Premier Investment Limited's (ASX: PMV) Just Jeans selling for AUD$70.

Competitive Moat

These are illustrations of businesses with differing competitive advantages.  Okayama has turned a commodity into a brand.  The people in Xintang focus on producing as many jeans as cheaply as possible.

Just having a competitive advantage alone is insufficient.  A business must protect its competitive edge.  Japanese handmade denim may be overtaken by the winds of fashion, perhaps by handmade silk pants sewn by virgins in China.  The factories in Xintang with rising labor costs may be replaced by automated factories in Japan taking customised electronic orders from customers worldwide.

The ability of a business to defend its edge is its competitive moat.

The business environment is never static.  Every single day, moats are either narrowing or widening. Apple and Samsung do battle every day, just like Woolworths Limited (ASX: WOW) and Coles of Wesfarmers Limited (ASX:WES).

The challenge for investors is to be able to purchase, at a fair price, a business with a widening moat.

The inverse logic is deadly simple, if the moat ain't widening….

Overseas Expansion

My brief ruminations on the denim industry now bring us to the repeated attempts, both past and current, of businesses in Australia to expand overseas.  In particular, the current focus is on Insurance Australia Group (ASX:IAG) and Australia and New Zealand Banking Group's (ASX: ANZ) Asian forays.

In his excellent book, Competition Demystified, Bruce Greenwald postulates that competitive edges are usually local in nature.  Consider the fact that  Australia is isolated. There is very little common links between Australia and its neighbouring the Asian markets.

We have differing cultures, and our relative proximity is tempered by ocean divides.  This lack of homogeneity means that investors cannot expect rollout successes such as McDonald's or Starbucks in the USA. The success of any business expansion will rely heavily on the ability of its business model to cross-borders.

If history is any guide, it is obvious that success stories are far and few inbetween.  The notable success stories are Cochlear Limited (ASX: COH), CSL Limited (ASX:CSL) and Computershare Limited (ASX:CPU). In these cases, I would argue that the competitive edge of each of these companies is clear.

Let's consider the many significant failures in the past. National Australia Bank (ASX: NAB) is still losing money in the UK.  ANZ (ASX: ANZ) has had previous unsuccessful forays into India and Indonesia.  The Fosters Group disaster in China is only superceded by its next disaster in wine (with its Rosemount/Southcorp takeover.  Telstra Corporation Limited (ASX: TLS) lost millions and millions playing with Richard Li in Hong Kong.  In each of these cases,  I would also argue that the lack of competitive edge is clear. After all, are IAG and ANZ bringing anything unique into the Asian market? And if not, can they do the same thing already being done in Asia, but better?

Foolish Takeaway

Management who never listen to history is doomed to repeat it.  But investors do not have to. Just listen to Warren Buffett:

"There is no easier game than stocks.  But make sure you don't play too often."

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The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Click here to be enlightened by The Motley Fool's disclosure policy.

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