How Economic Moats Fail —A Gillette Case Study
How platform shifts let startups win
Recently, I saw this video of a startup called Wisely, the Dollar Shave Club of South Korea. How did they find product market fit in an industry dominated by a monopoly, Gillette? The obvious but incomplete answer is that they had a great product experience at a cheap price point. But a superb consumer experience is a given. For me, the real insight lies in the answer to “What if Gillette lowers their price or launches a DTC (direct-to-consumer) subscription?” Back on this in a bit.
Warren Buffett famously invested in Gillette and made extraordinary gains, turning $600M investment in 1989 to $850M in two years, and then selling his stake for $5B to P&G in 2005. Looking through Buffett’s historical annual letters and annual meetings gives a hint as to what makes its business so powerful. Buffett touts in the 2002 clip that Gillette’s market share is 71% globally, and continues to grow.
“Five or ten years from now, I would be amazed if Gillette has lost market share…” — Warren Buffett (2002)
He says that its competitive moat is similar to that of Coca-Cola’s or Wrigley’s. Once people have acquired a taste for it, it’s not easy to change. You could consider the specific moats 1) brand and 2) distribution. (Also worth checking out Charlie Munger on Coca-Cola’s strategy: Turning $2 Million Into $2 Trillion)
Fast forward to today, and what Buffett once thought impossible has happened. Gillette’s market share has fallen from 70% to 54%. Their 2019 U.S. sales were $150M, while Harry’s came at $50M. Dollar Shave Club reached $225M in revenue in 2016 and got acquired by Unilever. P&G took a $8 billion writedown on Gillette in 2019. This David vs Goliath story is astonishing given that Gillette had a 100-year+ head start on Harry’s and Dollar Shave Club, being founded in 1901 vs 2012 and 2011 respectively. So what happened?
“What if Gillette adopts a DTC subscription or lowers their price?”
Back to the original question. In the U.S., Gillette had tried lowering its prices by ~20% and adopted subscription options, but to little effect. That is because it is not the subscription box that is important, but solving the consumer pain point of high price. And the truth is that Gillette is in a difficult position to solve the pricing problem. Why?
Size and cost structures: Because shaving is not a fast-growing industry, Gillette is reliant on advertising and price increases for growth. Gillette is already a giant company so must continue to grow this way. Cutting advertising budgets and lowering price would entail thousands of employee layoffs, lower margins, and criticism from Wall Street. In contrast, DTC startups like Dollar Shave Club and Wisely concentrate on selective, high ROI digital marketing. This allows them to pass savings to consumers and make that its brand ethos, while growing from a smaller base free of Gillette’s cost structures.
Consistency: Gillette sells the same product in over 200 countries. They cannot lower the price in one country to battle online-native brands, while charging multiples higher for the same product in another country. One can point out that companies like McDonalds offer country-specific products, but Gillette seems to standardize their product and save on cost. In doing so, they must maintain a level of price consistency to preserve its brand image.
Reliance on Physical Retailers: Selling through physical channels results in a 50% markup. Lowering prices on just the DTC channel would result in backlash from the retailers.
The cost structures in place made it impossible to change course in the face of a platform shift that was the internet. This is why startups can win.
(Note that in recent years, DTC brands have been selling through physical channels as well, because digital marketing’s ROI has fallen due to competition.)
A New Platform Shift — Crypto
As a crypto investor and nerd, I must tie it back to crypto. Crypto is another platform shift. Let’s look at an example with money markets.
A bank like Chase has many branches and existing cost structures they cannot change. That’s what led to the opportunity for digitally-native banks like Chime, which was recently valued at $25 billion.
In my mind, what comes after digitally-native banks are crypto-native banks like Aave and Compound. They are currently valued at single digit billions, but still have the potential to grow one to two orders of magnitude more (10–100x). Why? For the same reason Gillette can’t do anything about Harry’s and Dollar Shave Club — platform shift.
Crypto money markets allow anyone with an internet connection to borrow money at a set interest rate irrespective of economic, racial or geographic profile. It has these properties because it deals with a type of money that Bitcoin made possible — borderless, sovereign, censorship-resistant and programmable. You don’t get that with Chime, and never will.
Crypto also has a unique marketing and distribution model, much like how DTC brands differentiated with the online distribution model. Crypto companies can reward their users with tokens, which is a crypto company’s equivalent of equity. For proof, just look at protocols like Sushiswap, Maker DAO, and Synthetix that distribute earnings to token holders. For the first time in history, users of a product can partake in the economic success of a company. Imagine you used Uber, shared with friends, and earned equity instead of a measly $5 credit. You might be a millionaire now. Crypto shares the pie, which is an amazing distribution and incentive model. This is possible because crypto is programmable to allow seamless distribution of tokens.
It was interesting to observe how a Buffett favorite was disrupted by the internet DTC model. Looking forward, it will be interesting, and highly profitable, to invest in the next generation of crypto companies that will disrupt the internet incumbents.
Related: Naval Ravikant’s Monopolies Fall When Platforms Shift
How Economic Moats Fail —A Gillette Case Study was originally published in DataDrivenInvestor on Medium.
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