Andy Jassy once remarked, “When you look at whether a company is a monopoly or not, the first thing you look at is what kind of market segment share they have.” This insight is pivotal in understanding the essence of market dominance.
Investing in a business is about identifying those that dominate their markets. Why is this so important?
Consider the U.S. pharmaceutical industry. Over 90% of prescriptions are for generic and biosimilar drugs, yet those only represent 17.5% of drug spending and account for 1.5% of the total US healthcare spending.
When branded medicines lose their exclusivity, their average price typically declines by 66% for oral medications and 51% across the board in the first year alone.
The downward trend intensifies over time, with oral generics costing 80% less than their branded counterparts within five years, and a 67% price reduction for all medicines.
Price reduction occurs faster for oral medicines than for injectable drugs, which attract fewer generic competitors.
This trend significantly benefits many patients as 88% of all prescriptions are dispensed as low-cost generics.
However, world trade means more generic drugs start to enter the market at lower prices than the brands they replace. This ongoing price decline eventually renders the business’s profitability unsustainable, forcing the business to even close production lines.
This places generic drugs at risk of shortage. For instance, Akorn closed 75 generic drugs in February 2022. It had filed for Chapter 7 bankruptcy. In connection with that filing, the company has ceased all operations
In addition, Teva Pharmaceutical Industries which is one of the biggest generic drug producers of more than 500 drugs started to shift to brand name and high-value generics in response to the market dynamics.
This brings me to my main point: if you invest in businesses that solely compete on price and lack a strong brand presence it can be risky. Those companies are prone to losing significant market share and face precarious business prospects.
As the poet Ovid once said, “A horse never runs so fast as when he has other horses to catch up and outpace.”
While competition is a great thing as it forces businesses to become their best, for investors, being in a perpetual race isn’t ideal.
When comparing their financial information, there is a clear difference between Teva Pharmaceutical Industries and Alphabet which we consider a great business.
This stresses the importance of investing in quality businesses run by exceptional management with strong market share or monopoly power in the market.
Businesses that are obsessed with value creation for their customers find that in return customers will spend more in appreciation of the value that the business provides.
However, a monopoly can also be a disadvantage since there is no external pressure from competitors which can sometimes lead to complacency and satisfaction with mediocrity.
Since capitalism is brutal, even if you are profitable you will attract new competitors. Therefore differentiation and dominance are the keys to long-term investing, not engaging in price wars.
Awet Ghirmay, Head of Investment Research
If you want to learn more about this topic, please find the link here.
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Risk warnings
The value of investments and the income derived from them may fall as well as rise. You may not get back what you invest. This communication is for general information only and is not intended to be individual advice. You are recommended to seek competent professional advice before taking any action. All statements concerning the tax treatment of products and their benefits are based on our understanding of current tax law and HM Revenue and Customs practice. Levels and bases of tax relief are subject to change. This blog is based on my own observations and opinions.
