No Pain, No Compounding Gains: On Market Cannibalism

Barnes & Noble knew Amazon was dangerous. They had a choice to make. Do they dilute their profits by competing in the low margin/high cost e-commerce business? Barnes & Noble made the decision to enter the e-commerce market. Great, right? Nope. While entering the e-commerce market, Barnes & Noble decided to prevent the cash burning that Amazon was experiencing. They wanted the long term gain, without the short term pain. Obviously, this didn’t end well for Barnes & Noble. They were more afraid of burning cash than they were of Amazon. Worrying too much about cash cost Barnes & Noble more cash than they could ever imagine.

Amazon learned from Barnes & Noble. Kindle is a great example of this. Developing Kindle took a heavy investment from Amazon and ate into its core business. Why would Amazon hurt its core business? Because the pain was coming either way. Instead of worrying about the short term (cash) they focused on the long term (CASH). It sounds so simple, but in the moment it truly isn’t.

I love businesses that are future focused. If you get lost in the short term noise, you will never make it in the long term. Market cannibalism is where a business eats into its own profits with a new business venture (i.e Amazon hurt its book sales by releasing Kindle). Other common examples are Coca Cola releasing new flavors (part of sales of new flavors will likely lower other Coca Cola sales).

Cannibalism isn’t a great name for this. While you are eating into your own profits, you are doing it for the long term gain. Cannibalism doesn’t give that vibe (plus in general sounds icky). I’d prefer to think of it more like Hydra from Greek mythology. Hydra was a serpent with many heads. If one of Hydra’s heads is cut off, two more grow in its place. Short term pain leads to a long term gain. But honestly, it’s just disrupting yourself.

No matter what you want to call it, identifying this kind of long term focus is a key investing tool. When you hear analysts asking questions about short term impacts of decisions, it should be an eye opener. Unprofitability can come in several different forms, some of which are good. Investing in yourself in many instances makes sense. Study the business overall to understand where the profitability should be. Investing now for the long term is what you and companies should be doing. We should want to own businesses with long term focuses, not short.

Author: fatbabyfunds