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The case study of Capital Cities/ABC neatly illustrates a transition from a strong franchise to a business – a good business at that, but a mere business. Understanding the difference may be vital for investors.
In the early 1990s the writing was on the wall for old media companies as new technology threatened their ability to charge a high price relative to cost; advertisers were presented with a proliferation of alternative ways to attract attention. Buffett wrote to his shareholders in his 1991 letter:
“The fact is that newspaper, television, and magazine properties have begun to resemble businesses more than franchises in their economic behavior. Let’s take a quick look at the characteristics separating these two classes of enterprise, keeping in mind, however, that many operations fall in some middle ground and can best be described as weak franchises or strong businesses.
An economic franchise arises from a product or service that:
(1) is needed or desired;
(2) is thought by its customers to have no close substitute and;
(3) is not subject to price regulation.
The existence of all three conditions will be demonstrated by a company’s ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital.
Moreover, franchises can tolerate mis-management. Inept ma
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