A few weeks ago I discussed why the 18th century post office might be the best analogy to understand the role of emerging B2C internet platforms such as Facebook, Tencent, Netflix, and Amazon. I wrote:
The internet today might be best thought of as a number of category verticals: search (Google / Baidu), social (Facebook / Tencent), e-commerce (Amazon / Alibaba), entertainment (Netflix / Tencent), transport (Uber / Grab / Lyft), payments (paypal / mastercard, visa) etc. For instance, Alibaba-owned Ant Financial is using data from its consumer e-commerce business to underwrite new retail loans to consumers. Grab is trying to expand its transportation platform into payments through existing relationship with customers. Tencent is using its WeChat chat platform to expand into online stores and payments. In each case a direct relationship to the end consumer (B2C) is being leveraged to both dominate a category and attempt to expand into new adjacent categories.
More recently I’ve noticed how many ‘high-quality’ type businesses seem ripe for disruption once we incorporate these new models of B2C distribution. In the investing community there’s already been extensive discussion of Amazon’s disruptive effects to retail brick & mortar stores and consumer packaged goods (CPG) but these industry examples may generalize more broadly. In short I suspect distribution was the dominant frictional cost (and moat) of 20th-century business. Many of the barriers to entry that investors have traditionally identified such as economies of scale and brand lock-in could be the result of fragmented geographic dominance – remove those constraints through variable-cost customer acquisition and/or modularized low-cost distribution – and scale effects favoring the incumbents erode. The investment implication is our perception of ‘high-quality’ businesses may also have to change; stocks in emerging markets may particularly impacted.
Every business is local: town oligopolies to supra-national incumbents
Today’s supra-national incumbents may largely be the bottoms-up aggregation of local geographic dominance created by the frictional costs of customer acquisition and distribution (below). This effect has been described before by Prof. Bruce Greenwald re Walmart  and Peter Thiel in his book Zero-to-One .
Control of scarce local distribution in turn allows an incumbent to control other parts of the value-chain (below).
When B2C distribution channels change, do incumbents change?
To highlight a well-known example, historically newspapers controlled content + distribution which drove city monopolies. When the internet dis-intermediated the frictional costs of physical distribution removing its scarcity, the effect was to modularize and diminish the value of that content. Newspapers lost their monopolies.
Information goods such as newspapers are obvious victims of changes to B2C distribution networks, but we are seeing these effects generalize more broadly.
Below is an interesting chart from CB Insights appropriately titled “Unbundling Proctor & Gamble” showing all the emerging B2C brands disrupting P&G. In the below P&G brands are in the center of the graphic with new emerging brands arranged around the periphery: for instance, DollarShaveClub is replacing Gillette razors.
How many high-quality listed businesses are really distribution moats in disguise?
This framework might also apply to other businesses where disruption of existing B2C distribution channels erodes incumbents and enables disruptors operating on-top-of emerging internet B2C channels to flourish. Below is an anonymized list of companies I’ve considered recently which might be next. The industries discussed are at times broader than traditional targets of Amazon disruption:
Outdoor advertising is driven by local city dominance which provides economies of scale around distribution. The largest outdoor ad network have the widest geographic coverage, the most ad panels, lower maintenance costs, greater abilities to monetize outdoor ad inventory, creating higher profitability and ability to out-bid smaller competitors for new concessions. Small ad panel owners could list their panels directly on online platforms, removing many of the scale advantages of incumbents.
National window installers generate most of their leads from door-to-door canvassing and national TV brand advertising. National installers have more canvassers which were *locally* dominant in their neighborhoods, which created a business which could afford national advertising and realized economies of scale in manufacturing. Today SME-owned installers can use online distribution platforms to convey both quality and price, creating a direct link to customers which is modularized and variable cost.
Cruise ships generate profits from a good cruise product, but superior economics comes from the ability to fill the ship (load factors), port slot scarcity, and the marketing / distribution network of travel agents. If we change the how the product is distributed (online OTA’s), can we change the incumbents? This might describe the business model of German travel company TUI.
Retail asset management is the product of dominant *local* fund wholesalers who regularly market to independent registered investment advisors or captive distribution channels such as local brokerage offices (Edward Jones). Is AUM the summation of local distribution dominance or superior products?
Potential implications for emerging markets investing
While there are important exemptions to these generalizations, some implications for investing might be as follows:
First, I suspect many high quality listed businesses in emerging markets were driven by frictional distribution advantages, not always superior products. These advantages may diminish as new products are developed and distributed over modularized distribution channels such as Amazon Logistics, Lazada, and Alibaba. Many of these new product businesses are unlisted and operate with low capital intensity and highly variable cost-structures.
Second, many emerging markets lack listed B2C platform businesses – for instance in the prior essay none of the companies discussed were created outside the US or China – depriving many emerging markets stock markets of this growth.
Third, drastically changed distribution chains and modularized supply require less duplicative capital, reducing the need for capital. Albert Wenger of Union Square Ventures has some interesting conclusions around this point in his podcast interview and open-source book which suggests the effects on economies could be much broader.
If correct, this is not to say that investment opportunities in emerging markets no longer exist. It simply may be some recognition that investors need to recalibrate their business analysis to reflect radically changed circumstances.
As always differing perspectives are welcome. This essay is simply my effort to share one of the puzzles I’ve been grappling with.
 “Greenwald talks about Walmart being a value trap, and states that American Express is a good buy. Greenwald is known for being bearish on Walmart. He thinks they do not have an edge in places overseas where they are trying to expand. He believes the company would be better off expanding into untapped domestic markets where the company has the advantage of economies of scale. That is how Walmart began its dominance by slowly expanding from outside of Arkansas. Walmart will have no edge by opening up a store in Shanghai or some other distant city.” accessed on, https://www.gurufocus.com/news/95886/bruce-greenwald-discusses-walmart-and-american-express
 Zero-to-One by Peter Thiel, Chapter 5: “Every startup is small at the start. Every monopoly dominates a large share of its market. Therefore, every startup should start with a very small market. Once you create and dominate a niche market, then you should gradually expand into related and slightly broader markets.”