When Looking For Stocks To Buy Keep This in Mind...

When it comes to strong brands, geographical location will be of little relevance.(Representational)

Every time I go to a Mc Donald’s to have my favourite burger, I always spot a Burger King outlet next door or within 50 metres of it.

I can understand if its in a mall as all major outlets have retail space in the food court of a mall, however these are outlets in open spaces.

In fact, this true for car dealers and petrol pumps too. I’m sure, you must have seen a cluster of auto dealers. Many fuel pumps too, are located adjacent to each other.

To put an end to my curiosity, I did a google search to find the reason why competing brands are situated next to each other? I mean, isn’t it counter intuitive?

A gentleman on twitter had posted a thread on the same question.

Let us take the example of two petrol pumps which are adjacent to each other, say BPCL and IOC.

Imagine there is a 1 km stretch at the end of a highway where BPCL and IOC are thinking of setting up petrol pumps.

Logically, they could split the 1 km stretch equally and locate themselves exactly at the centre of their respective half.

In this case, IOC could be at 250 metres (m) while BPCL could set up the petrol pump at 750 m on the 1 km stretch.

This way the customers coming from the right will go to BPCL and the customers coming from the left will go to IOC. Also, the customers from the centre will be indifferent going to either of

the petrol pumps as the distance will be the same from the centre. In this way, the market share will be 50:50.

This is ideal for consumers too as they can all fill their tanks by traveling less than 250m in the 1km stretch. That is why game theorists call this situation a ‘socially optimal solution.’

However, the world is dominated by greed and animal spirits. In a jungle, logically, the lion and tiger should be friends. That way both won’t go hungry and hunt together.

However, there is only one king in the jungle, which is the lion.

So, coming back to our example, say BPCL becomes greedy and wants to make more money and decides to snatch away the IOC’s customers by simply moving to the middle of the 1 km road.

Now IOC is located on 250 m on the 1 km road and the BPCL moves to the middle of the 1 km stretch and is located at 500 m. BPCL gains market share as it is now serves everyone from the right half and also gets some demand that used to be Indian Oil’s earlier.

Of course, Indian Oil wouldn’t stand for this. It will also move to the middle, resulting in clustering.

This is what we see when we look at McDonald’s and Burger King too. This case where both are located next to each other in the middle is what game theorists call the Nash Equilibrium. This lesson on competition is useful for investors when we select stocks to buy.

In the example of petrol pumps, the most important factor was the convenience of location. This is because the product sold was a commodity. The fuel quality is the same at both places.

Hence the fight was for the convenience of customers when it came to distance and things like going round on the other side of the road in case of the petrol pump.

Let’s take movie theatres for example.

If we compare two luxury theatre chains i.e. PVR and Inox, both have the same quality of comfort and pricing. I’m sure the distance of the theatre from your home or office would be one of the most important factors in your decision.

Location matters the most when setting up a theatre. That is the reason why financially stronger multiplex chains like Inox and PVR have an edge over small theatres.

However, the story is not the same for quick service restaurants like McDonalds, Burger King, Dominos, and Pizza Hut.

People’s preferences are an important factor as taste is involved. A person who likes burgers from McDonalds will not mind taking a detour or travelling a reasonable distance to satisfy his taste buds even if a Burger King is close to his house.

When picking stocks, there will be certain industries where competitive intensity in the form of geographical advantage will determine market share and company performance. In other cases like strong brands, geographical location will be of little relevance.

Keep this is mind when you’re looking for your next stock to buy.

This article is syndicated from Equitymaster.com

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

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