30: Against The Grain: Capital Intensity As A Source Of Competitive Advantage
Not every industry is better served by going digital
Last week I embarked on a plan to increase the frequency of this newsletter from once every Friday to 2 or 3 times per week. Most of you loved the idea while a few expressed a desire for less frequent communication. Good news, friends! We can have our cake and eat it too!
Introducing The Classroom
Substack allows for separate newsletter sections. To accommodate more frequent content I’m introducing “The Classroom”. The Classroom will be a separate newsletter (still under the Watchlist Investing header) with all sorts of goodies. I envision curating material from the Berkshire Hathaway annual meetings, my book, and other interesting investing material together with some commentary of my own. I don’t have any frequency in mind but perhaps one or two times per week, which will be on top of the weekly Friday edition.
Right now you’re on both the regular Friday newsletter and The Classroom distribution lists. If you want to stay on both you don’t have to do anything. If you’d prefer to receive one or the other simply log in and make the change to stop receiving email notifications. Substack makes it easy.
Thanks for being on this journey with me! -Adam
Capital + Tech = Moat (Sometimes)
Asset lite is all the rage these days. Tech companies aspire to cloud-based everything and even run-of-the-mill companies try to SaaS themselves up somehow. And with good reason, mind you. Winners disproportionately take home the spoils.
But you can’t eat bits and bytes. The physical goods essential to any economy must get to their final destination no matter how technologically advanced your civilization.
Enter the class of companies winning by wedding old-school capital intensity with new-age tech. In a previous issue of the full paid version of Watchlist Investing, I looked at Old Dominion Freight Line (Ticker ODFL | Disclosure: None).
ODFL’s strategy embraces capital intensity as a means to better serve its customers. Oh, and it disproportionately makes up for it in higher operating margins and higher returns on capital. A larger and denser service center network, a goal to bring as much line freight in-house vs. outsourced, both are rewarded on the back end with superior economics compared to peers. Technological advances created a tailwind for ODFL as it prices and routes shipments, and as automated technology is introduced into the system.
ODFL’s competitors, by contrast, have tech-envy or something of the sort. They try to operate in a capital-intensive business in a less asset-heavy manner—to their detriment. Outsourcing transportation leads to loss of control, higher claims, and lower on-time rates.
Take a look at ODFL compared to YRC (a disaster of a company) and ARC. Saia is taking a play out of ODFL’s handbook but isn’t quite there yet.
Next month’s paid subscriber issue will feature Fastenal. FAST has embraced a similar strategy of embracing capital intensity by investing in a physical branch network. Its peers have largely gone the route of using technology to create big catalogs of products but that ultimately still rely on third parties to ship. FAST is closer to its customers and is rewarded for it. And with the introduction of industrial vending FAST has a tailwind at its back.
These two examples show that capital intensive doesn’t automatically equate to poor economics. Industries like LTL trucking or industrial distribution simply require a lot of physical investment to drive good financial outcomes. Fighting the basic economics of your industry only leads to worse outcomes.
What other capital-intensive businesses are worthy of study?
Stay rational! —Adam