How We Think

Focus On The Customer’s Decision

Earlier this month, Kraft split into a faster-growing international snacks business and a slower-growing domestic foods/grocery business.  Despite neither of the companies’ fundamental business prospects changing one iota, the market reacted to the news by trading both of the stocks higher.   We used this opportunity to liquidate our stake in both companies.  It is popular, even within our value discipline, for investors to advocate various financial engineering strategies in an attempt to drive near-term stock price appreciation rather than to focus on a company’s long-term cash flows — where real value resides.

Because the size and duration of cash flows are ultimately a function of a company’s competitive advantages, our core emphasis as investors is on correctly assessing the sustainability of these advantages.  We believe a critical aspect of this analysis is to understand why a company’s customer makes the decision he does and whether he is likely to repeat that decision.  For example, how important is price?  How important is the price of a substitute?  How important is the price of a complement?  How important is availability?  How important is service?  This analysis holds irrespective of whether the customer is a four-year-old child buying M&Ms or an oil producer leasing an off-shore drilling platform.  In our search for investment opportunities across the world, we try to identify management teams who clearly demonstrate a focus on the customer.

Last month, we had dinner with Arca Continental’s management to celebrate the retirement of Dr. Adrian Wong, who has served as CFO for the last decade.  Adrian recounted the initial meeting of the new management team in 2001, when three independent family bottlers combined their assets to create Embotelladoras Arca.  CEO Francisco “Pancho” Garza announced that he was going to go around the room and ask each executive what he did for the company.  Adrian was first, and instead of giving a complicated answer about the role of a CFO, he simply answered, “I sell Cokes.”  Pancho responded, “Exactly!”  Furthermore, Pancho is fond of telling people, “The customer is the boss!”  He says this not in the aphoristic “customer is always right” way — consumers would love free Cokes although that would be unsustainable — but rather from the perspective of “how do we anticipate and satisfy demand?”

With these and other similar points of emphasis, Pancho leads a culture that lives and breathes a focus on the customer.  Arca has created a number of programs within the global Coca-Cola system, including offering a plethora of sizes and price points to meet highly varied customer demand situations.  We observed this program being copied in Poland this summer.  The company also recently began a program where Arca employees train mom and pop store owners on techniques that will increase the overall sales in their stores (beyond just Cokes).  This informal market is the most important distribution channel for Arca, as the company enjoys higher margins and a superior competitive position within it.  The program improves the experience for consumers, generating more foot traffic that both expands Coke sales and makes the store owners loyal to Arca for years to come.  Stronger informal retail shops can better sustain pressure from the formal channels, which include convenience stores like Oxxo and hypermarkets like Walmex.  Arca Continental continues to innovate new ways to delight its customers, and we remain grateful shareholders.