Some companies are just better than others. There are a number of attributes that make a good company stand out from the herd including name recognition, innovation, and market share. The important thing is for an investor to spot the eventual winners before they become household names.
So, what makes a great company? And does that description necessarily equate to a good stock option as an investment? The answer depends on whether you ask an accountant, an economist, a marketer, a human resources (HR) expert, or even the company itself. But by pulling all of those disciplines together, you generally can define a good company.
In this article, we look at three key attributes that make a company successful. Learn to spot them early, and you could find yourself riding their coattails to success, too.
- Companies need to maintain a competitive advantage in order to stay in business.
- Barriers to entry, name recognition, and price leadership can all help firms remain competitive.
- If a company has above-average management—people who have experience and have been with the company for a long time—there's a good chance that the company will be a success.
- Companies can achieve market leadership through quality, innovation, customer service, or even warranties.
A competitive advantage is any characteristic that a company has that helps it keep up with the competition in the marketplace. Companies need to maintain a competitive advantage in order to stay in business. Author and Harvard Business School professor Michael Porter, who came up with the Five Forces Model, also pioneered the concept of competitive advantage, breaking it down into two forms—differentiation advantage and cost advantage.
Differentiation advantage is when a company provides a superior service or product for the same price charged by the market. Cost advantage, on the other hand, is when a company provides the same service or product as the market but at a lower price. Porter collectively refers to the two concepts as positional advantages because they define a firm's position as having the leading service or product in its industry. According to Porter, these advantages aren't fully sustainable because the promise of economic rents invites the competition. This is the amount earned on top of what is necessary from an economic standpoint.
The following are a few key factors that can help companies keep up their competitive advantage in the market.
Barriers to Entry
Good companies can maintain their high status if there are significantly high barriers to entry into their fields. Some of the most common barriers to entry include large fixed costs, such as those associated with heavy manufacturing, or long-term research and development (R&D) costs, like those found in the pharmaceutical or computer software development industries. All of these entry costs can deter competition from entering the market, thus helping the company sustain its leading status.
We tend to take the value of name recognition for granted when looking at a company's status. Take, for instance, companies like Kimberly-Clark (KMB) and Coca-Cola (KO). Brand names like Kleenex and Coke have become synonymous with their products.
But there's one problem with name recognition—placing a value on that name. There's really no easy way to do that. A name only has qualitative value, but it can provide a long-term relationship between a company's products or services and its customers. While it can be debated whether this trait alone makes a company good, when combined with the other characteristics it can be a powerful source of success.
While name recognition may boost a company's profile in the market, keep in mind that it only has a qualitative value.
There is nothing more powerful than providing comparable services or products to the market at a lower price. In any economic environment—whether it's a boom or a bust—there will always be a demand for low-priced services and products. Being able to come to the marketplace with consistently lower prices across the board can fill a niche in the market that can attract customers for an extended period of time. The key in price leadership is being able to sustain that level and fend off others who try to compete in that space.
The quality of a company's management is a big factor in whether a company is successful. One of the most important attributes in any management team is a blend of experience. Experienced managers can not only lead a company through market cycles, but they can also provide mentorship for the next generation of managers.
Another telling attribute is when management tends to stay at a company for a long period of time. Talented managers can be swayed to move from company to company with very attractive compensation packages. If they tend to stay at companies where they like to work, it's usually because they believe in the future and success of their companies.
One of the most important characteristics of becoming a good company is market leadership. Leadership can come in many forms, but the reputation that comes along with this tag is priceless. An industry-standard label is one that every company strives to achieve. Examples include leading the market in quality, innovation, customer service, or even warranties.
Market leadership is probably the hardest status to maintain. No competitor is content just being in the second position in the industry. This is where barriers to entry come into play. If you're interested in a company that competes in an industry with high barriers to entry, it's much more likely that its market dominance may continue. Companies can also move toward market leadership by buying and merging with other successful companies to improve their market share, vertical and horizontal integration, and technological bases.
The Bottom Line
So what exactly is it that makes a company a good company, and does that necessarily lead to a good rating result for a good investment? If the company has a competitive advantage, above-average management, and market leadership, there's a very good chance that you're looking at a potentially strong option for investing. While these traits alone don't necessarily tell the whole story, they are important factors when it comes to evaluating whether a company might be recognized by investors globally as a good investment.