This week’s podcast is about “criticality” as a type of switching cost. And specifically about Wabco, one of Warren Buffett’s companies that has fairly powerful B2B criticality.
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From the Concept Library, concepts for this article are:
- Switching Costs
- B2B Customer View: Necessary vs. Critical vs. Strategic
From the Company Library, companies for this article are:
- Warren Buffett / Berkshire Hathaway
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Welcome, welcome everybody. My name is Jeff Towson and this is Tech Strategy. And the topic for today, Switching Costs, WABCO and Buffett’s Critical Companies. That’s a bit of a long title, but basically I’m gonna talk about switching costs and how Warren Buffett has for decades been investing in companies that are B2B where a critical switching cost is generally the primary thing I think that’s attracting to him. and I’ll take you through one of them which is called WABCO, which is a pretty interesting company, but this is mostly going to be about switching costs from the guru of competitive advantage, Warren Buffett. Okay, first I guess a qualifier or maybe a little bit of a mea culpa. I put up a podcast the other day on IoT and DHL and all that, and I don’t think it was too good. I think it was, it wasn’t terrible, but I think it was seriously mediocre. So I’ve been kind of feeling bad about that for a couple days, so I put a lot of time and effort into this one. I was kind of, I think it was post-COVID vaccine. I was kind of wiped out. It was airplanes in New York, in Texas, in Mexico, in California, and… Yeah, I just think I was on my game. Anyways, but working a lot on this one, so hopefully this one will be great. Um, well, I say that now, but we’ll see. Now, for those of you who are subscribers, I’m going to be sending you out some stuff that I’m working on in the near future. One I mentioned already which is his company Truck Alliance which is kind of like Uber for trucks, you know, connecting cargo haulers, big rigs with shippers and receivers. It’s a Chinese company, really interesting. The numbers for that are out, so that’s really interesting. And the other one, of course, coming up is the Big D.D. IPO which is apparently weeks away, so we’re finally going to see their numbers. They’ve said openly over the years that they’re operating profitable We’ll see but the numbers are gonna be big either way because we know the volumes are massive So that’ll be kind of a big focus. I guess in this next month And for those of you aren’t subscribers feel free You can go over to Jeff thousand comm sign up there for 30-day trials. See what you think And last thing my standard disclaimer nothing in this podcaster in my writing or website is investment advice The numbers and information from me and any guests may be incorrect. The views and opinions expressed may be incorrect, no longer relevant or accurate. Overall, investing is risky. This is not investment advice. Do your own research. And with that, let’s get into the topic. Now, first, the concepts for today are switching costs, which is obviously a big deal. It’s a big deal in digital. This is not really going to be a digital day very much. But the principles is actually really important, especially when you look at SaaS companies, enterprise, things like that. Switching costs are a huge deal in software, AI, and everything like that. So this is kind of a good example of switching costs. But it’s a pretty old school, traditional company. So that’s one idea that’s important, switching costs. And the other one is what I call the B2B customer view, necessary versus critical versus strategic. I’ve talked about that before. That is, well, I’m not going to do it in a little bit, but both of those are under the concept library, so you can either look up switching costs, or you can look up critical. I mean, B2B customer view where it is perceived as critical. And I’ll explain what that means. Now, WAPCO is a really interesting company. It got on my radar years ago. I basically, anytime Warren Buffett buys anything, I… I immediately stop what I’m doing and I try and reverse engineer it without looking into why he did it. I just pull the latest annual and see if I can get to the same answer. And mostly I can. I’ve gone through so many of his companies, really going back 40 years over. I’ve been doing this for five to seven years. I can pretty much get most of them. The ones I struggle with are in energy and in financial services like banks because I don’t really… That’s not a… great area of expertise, but the rest I seem to do all right. Anyways, he bought into WABCO, I’m going to say seven years ago, but I might be off by a couple years. And it was an interesting company because I’ve been talking a lot about B2C companies because digital in Asia, that’s really where most of the action is. Haven’t talked as much about B2B, which we see in Europe and the US, but not as much in Asia yet. But this is one of his B2B companies that he bought into called WABCO. which is basically a very old company. I mean, we’re talking about 150 years, founded in 1860. The original name of the company was the Westinghouse Airbrake Company. And they basically make brakes. And back then it was air brakes. And that’s all they’ve pretty much ever done, as far as I know. They’ve had lots of different names. They’ve been bought and they’ve been sold and whatever. You know, as cars, trucks, trains. as the whole transportation sector emerged and evolved. They just stayed basically in the braking business and that’s still what they do today. Today they’re mostly focused on Europe, although they are global. They work closely with the major equipment manufacturers, the OEMs, that basically make trucks and to a lesser degree buses. So when you’re going down the highway, 70 miles an hour and you see those big rigs streaming by you, you know, that’s who’s doing the brakes for them. And you know, they’ve sort of evolved with them to what you would consider the most difficult aspect of the braking business, which is these are very big vehicles. They can cause a lot of damage. They’re very expensive. If the brakes fail, safety is a huge concern. And also the braking systems have become more and more advanced as these trucks, like most automobiles and vehicles, as the engine management systems, as the suspension systems and as the braking system have become more technology laden. This company sits within that sort of intersection of braking, safety, and fairly rapidly increasing technology. Within, you know, particularly braking. I think they mostly do branking and suspension systems that are increasingly electronically controlled. But that’s what they do. These are all commercial vehicles. Typically it was mechanical. Now it’s a mix of mechanical and electronic. They have about 11,000 employees. About 1,200 of them are in R&D. So doing technology. They do do a couple other things like trailers and such, but basically, they’re doing the braking systems with pretty much all the leading commercial truck makers out there. And these companies, the ones they work on a lot are in Europe, but their markets are global. So these companies are selling all over the world. Some of the technologies they work on, I’ll give you some of the stuff from their annual report, the modular braking system. which can basically switch between anti-lock brakes and electronic braking. On Guard Active, which they described as an autonomous emergency braking system. Basically, it can stop automatically on its own. Cruise control for trucks. Fleet operator, where you have a single screen where the control tower can see all the buses. Air suspension technology, things like this. Their biggest market, as I said, is Europe. They are described as the supplier of choice. They do have joint ventures in India and China. They have some facilities there. So their workforce is more or less global now. Some of the manufacturing is done in lower cost countries, but it’s a sort of a, their market is 60, 70% Europe at this time, but then they do lesser degrees in US primarily and then Asia Pacific. 20 plus manufacturing sites on four continents. Here’s kind of the financials, which are really simple. two to three billion dollars worth of sales U.S. Operating profits are about 13 to 15%. Their gross profits are about 30%. And it’s pretty stable. Free cash flow is about 10%. So I mean, it’s not a huge business. It’s not growing dramatically. The revenue’s in the couple billion dollars range. But it is nicely profitable at the gross profit level. at the operating profit level and at the free cash flow level. All the numbers look quite nice. And then they have a backlog of one point, well I’m reading the numbers from a couple years ago, so approximately $1.5 billion in a backlog. So that’s always a great sign to see. The financial is just nice and simple and they’re pretty. manufacturers and then everything else. The next biggest sector would be the aftermarket for products and services. So maintenance, supplies, things like that. That’s about 25%. So that’s 85% of their business and then they do some little stuff outside of that. The top 10 manufacturers for them represent 54% of their sales. So highly concentrated on the consumer side, at least in the OEMs. When it comes to the aftermarket for products and services, that’s every little auto shop here and there that handles trucks. So that’s pretty fragmented. So the main part of their customer base is pretty concentrated, the major truck manufacturers. And then the aftermarket, which is 20% to 30% of their sales, that’s pretty fragmented region by region by region. And they’ve got a couple of competitors, not many, three to four, Bosch, some in Asia, some in China, there’s a couple of them. So what does the company do? Well, I mean it’s pretty simple. They design, they develop, they engineer, and then they test braking systems. And that’s, you know, 10 to 20 percent of their employees, that’s what they do. So if you look at their headcount, you’re going to see a big skewing towards basically R&D department with a lot of engineers. And if you look at the spending on R&D, it’s about 5% of their revenue, so that’s pretty significant. And they’re pretty capital light. or at least their tangible asset light. Their PP&E net is about $450 million. So, against two to $3 billion of sales, I mean, this is mostly, it looks mostly like a tech company with a lot of engineers, some high gross profit products, and some degree of facilities, tangible fixed assets, but not a huge amount. So why would this company get Warren Buffett’s attention? I mean, I always sort of walk myself through this, any company from the customer view, what does the customer care about? What is their process? How do they engage? How do they buy? How do they use? How frequently? And then I look at it from the competitor standpoint as well. And when you look at it from the customer standpoint, which is, you know, this handful of large truck OEMs, the number that jumps out is really, there was really three factors that jump out in terms of what they care about. And number one on the list, actually number one, number two, and number three on the list is safety. If you look at their annual report, the word that jumps out on every page is safety. This is all about Dear God, don’t let these brakes not work like they’re supposed to. Not today, not tomorrow, not five years after the truck has been on the road, not ten years after the truck has been on the road. Dear God, let’s not have a report of five of our trucks with the brakes failing hit the news. One, that’s bad for people because they’re going to get hurt, but you know you have a bunch of these trucks where there’s a problem and if people point the finger at the brakes, you’re looking at a major recall. So yeah, it’ll hit the braking company, but it’ll really devastate the trucking companies that make these. So number one would be safety. You see it all over the place. And second to that. The best technology, so staying on the frontier of braking and suspension technology, and number third would be efficiency. Not ridiculously expensive. But it’s really those first two that matter. That’s what jumps out. And that gets us to the sort of concepts for today, which is what is a critical product within a company? A critical service, a critical product. What does that mean from the perspective of the buyer? When the buyer has to buy all their parts, all their services, everything they need, there’s a small number of things they buy that would be under the category of critical. The vast majority of things they buy would be under the category of necessary. Okay, you’re a university, you need a bunch of tables. Fine, buy the tables, it’s necessary. Get the best price you can with acceptable quality, make a rational decision, fine, fine, fine. Some expenditures in a B2B transaction when you’re the buyer, you’re a company, could be considered strategic. This is not an expenditure where we’re trying to save a ton of money, where we’re trying to cut costs as deeply as we can. This is the marketing. In that case, it’s a strategic expenditure. In fact, we may well want to outspend our competitors to beat them in this area. So let’s say you have necessary expenditures as a business, you have strategic expenditures in things like R&D, marketing, sales, and then you have a very small number of things that you could put under the category of critical, which is these are the areas where we spend money. And if something goes wrong, it has far greater impact than just a broken table. If I buy a table and it’s bad, it’s not a big deal, I buy a new table. If I buy the brakes for my entire fleet of trucks, those brakes have any problem. One, there’s safety concerns. Two, it wrecks those particular trucks because the whole thing is integrated within those particular trucks. And three, I probably have to recall the whole line of trucks. Four, it may bankrupt the whole company. So this little expenditure, because it’s critical, has a much larger impact on human cost, societal cost, products, It’s a big deal. And that’s one of the concepts for today, which I’ve called B2B customer view, critical versus necessary versus strategic. And those are in the show notes. But OK, how do you know if something is critical? Well, I have a list of questions. I’ll give you some of mine. First question, how is it critical? How does it impact a larger product or service than just itself? If you’re building cars and the tires are bad, It’s not that big a deal, okay, a bunch of the tires popped, the next round we’ll just replace those tires and in the next round of cars we make, we’ll buy from someone else. So yes, there’s an impact in the fact that the tire was bad, but it’s reversible, it’s easy to undo, it doesn’t impact anything larger than that particular problem itself. Now if you’re talking about a braking system, well those things are engineered into the car, they’re designed into the car. manufacturers probably for years very closely in the design process for the trucks. They’re designed in, they’re engineered in, they run all through the system. If you have a problem with your braking system, which is increasingly electronic, you can’t just swap that thing out like a tire. You know that’s not an easily reversible decision. So one, it doesn’t just impact the tire, it impacts the whole truck. So that’s sort of, let’s say, taking it up to the next It could hurt your reputation. If it turns out you’ve got bad tires, bad braking system, it hurts your reputation, it hurts you with clients. That’s one level of impact. Second level would be, okay, it wrecks a larger project. If you’re using sort of a roof sealant, a coatings business, which is another thing that Buffett invests in, you put those on the roofs of houses, of commercial buildings. It’s not a big expenditure. But if it doesn’t work like it’s supposed to, when it rains, the water goes into the entire building. So it has a much bigger impact than just that little powder and coating you bought. If you’re doing a clinical trial and you buy a bad machine that’s part of your testing, you might wreck the entire trial because it’s unreliable. So you can go to a larger project. In this case, the braking system could wreck the entire line of trucks. Third level, does it hurt people? Do you lose lives? Is it a failed drug? Is it a failed pacemaker? Are you using contaminated plasma where the screening mechanism is not working and suddenly you’ve got basically HIV positive plasma going all over the US, which is something that happened. So much wider impact there. I guess highest level here, well that one was probably the highest level, but say another big level would be be do you lose the entire company? If you’re an airline and two of your planes crash in a year or so, you’re pretty much out of business. And that’s happened a handful of times. So when you think about that would be the first question is, how is it critical? To what degree? What would be the cost of using a cheaper product and then having a problem? Because ultimately, businesses are cost benefit calculators. So they look at, OK. If I do choose to swap out my WAPCO braking system for a competitor who’s 20% cheaper, what is the cost if something goes wrong? Okay, question number three, how long is this gonna be used? Is it easy to replace if there’s some sort of problem? Now, if you’re building a product, let’s say a component in consumer electronics, like a smart TV, okay, you might have a problem, and your line of TVs might not be able to last 20 years, but people don’t use their TVs for 20 years anyways. I mean, it’s a couple years. So it’s not like the product is gonna be used forever. However, trucks are used for a long, long time. One example that Buffett has invested in has been the company that makes airframes for Boeing and Airbus. These are the structural airframes that are the basic body of the airplane. Now when Boeing makes a plane, that thing can stay in the air and stay in use for 25 years. So it’s gotta be so well done that when you buy this component, your airframe from an airframe company, you are comfortable with that being used for 20 years. So one, it’s used for a long time, and two, even if you have a problem, there’s no way to replace the airframe of an airplane. So that would be kind of the next one, is what is the lifespan? How long is this product used? Is it easy to replace? Car tires, very easy. The engine management system is actually pretty hard to rip out and put in a new one, as I kind of mentioned. Question number four, how many companies are proven to be acceptable for this product? Are there acceptable alternatives? Maybe there’s only two or three, which I believe is the case with Wobco. Maybe there’s 20. That would be a different scenario. Okay. How difficult is it for an unproven company to become proven? If one company hasn’t, let’s say a biotech device, a pacemaker, okay, there’s a lot of criticality in that, but there’s actually a very well-known process for a new company to prove its quality, which is FDA. The FDA tests it, it goes through the clinical trials, the FDA stamps it, and therefore you know this has an acceptable level of quality for this critical product. Okay, how do you do that for the airframe of an airplane? If someone comes to you and says, I have a new airframe that’s just as good as the one you’ve been buying, Boeing, how does Boeing possibly test the quality of that airframe that will be used for 25 years? There’s no test for that. I don’t even know how you’d do it. I don’t think you can. I think you just have to go with the one you’ve always gone with. And then you put all these questions together as the buyer and you say, okay, what is the risk versus the cost savings? for going with an alternative to the one I’m used to. Isn’t that how that people make decisions? And for something like WABCO, one of the questions within there would then be, well, how expensive is this thing anyways? You know, a big truck costs quite a lot of money, and it turns out this braking system maybe only costs 3 or 4 or 5 percent of the cost. So let me get this right. This is a critical product. If I buy… It’s a critical product where it is very, very difficult to prove quality as acceptable. So if I switch from company A, which I’ve always used, to company B, which is unproven, I might save 20% of 3% of my entire project. But if something goes wrong, we lose the entire company. It’s that trade-off between how important is it and if I try to go cheaper, do I actually save any money or is it such a small percentage of the cost structure, who cares? Now, one of my old students, he was out in Europe and he was looking at a company and we got talking about it. I’ve told this story before on this podcast, I think, and I kind of said, well, what’s this company? He goes, well, they only have one product. They make the little pellet that explodes within the airbags of automobiles. Well, that’s a funny business. All they do is make the pellet that explodes. He goes, yeah, the pellet explodes. That’s what inflates the airbag. And that’s pretty much all they do. And it was only, you know, the cost of making this pellet was a couple dollars. But they were selling it to the companies for something like 20 to 30 dollars. I’m making those numbers up, but they’re about right. And I was like, that’s the greatest business I’ve heard of in a long time. Like, think of the criticality of that product. and that if the airbags don’t explode, what that means for the car, what that means for the car company, I mean you could bankrupt, you’d have to recall an entire fleet of cars if that thing doesn’t go off. And you’re probably going to lose the company. And yet, what purchasing manager at an auto company is going to nickel-dime over a $10 product that’s critical? So they don’t care about $20 versus $10, but if you’re the company selling them, you’re making a massive gross product or gross profit. So I love that dimension of, it’s incredibly critical and it’s a very low cost structure. Now the weakness of that model is it’s actually pretty easy to swap them out. If you had a problem with the pellets, you could probably just pop out the airbag and pop in a new one in all your vehicles. So you’re probably not doing a recall. So it’s actually kind of a reversible problem. It’s not like one of these business decisions. where you make the decision and you’re stuck with it for 10 years. You could pop out the airbags and put in new ones, but it’s still pretty attractive on the cost side. Okay, two last questions I typically ask when I’m thinking about a critical product. Number one, are the operations or technology integrated with the buyer? And that’s really the case here, like these braking systems, the suspension, you know, the design team of WABCO is working with the design team at various truck manufacturers. They’re probably in the same town. They’re meeting all the time. You’re designing these things in. There’s a level of operational integration that is very hard to separate. So I like that. And the last one would be, are you protected by patents? This is a technology company. Now, if it turns out Webco has a whole list of patents on breaking technology, that’s even better. And when you look at Webco, you can pretty much see most of these factors. They’ve got patents. They’re operationally integrated. It’s a small percentage of the cost structure. It’s a long lifespan product that’s very hard to swap out. It’s designed in. It has a certain level of criticality that’s, you know, you’re probably not gonna lose the entire company if you have a problem with your braking system, but a lot of people could get hurt, and at the minimum, you’re gonna have to recall a huge number of vehicles. So when I look at this company and think, okay, why did Buffett buy this? I mean, that’s really what jumps out. This is perceived as a critical product for the truck manufacturers. And even though the market is fairly concentrated, there’s only a handful of them, it’s also concentrated on the truck breaking technology companies. So it’s a fairly strong position in the value chain. And that brings us to the other concept for today, which is basically switching costs, which I’ve talked about quite a bit before. the revenue or demand side competitive advantages. I mean, this is a powerful competitive advantage. It’s one of the best ones. We see it in software all the time, and it’s a type of customer capture. So simplest example, end of the year, your accountant comes up to you. You’ve had your accountant for five years and says, oh, I’m sorry, my friend, but you know, times are tough, costs are going up. I have to increase my fees by 10% this year. And you think, oh okay, 10%, it’s not terrible, I don’t really want to pay it, I suppose I could switch to another accountant, but they’re not going to know my business that well, there’d be a learning curve, it would take time for me to switch over to ship my information, they may not be as good, there’s a chance they could make a mistake, which might end up costing me, I know at least this person doesn’t make mistakes. Anyways, there is a perceived and or real cost to the buyer. that is, you know, one it could cost money to switch from supplier A to supplier B. There’s a hassle factor. There’s uncertainty. There is risk, which can be real and perceived. And there’s a certain amount of time required to do all this. So you weigh all that and you decide, is that worth more than 10%? And you say, okay, you know, it turns out the cost of switching is greater than the 10% increase. So it makes sense for me to stay with my current accountant. And you know that happens all the time. A lot of businesses do this. Storage facilities, I was just at a storage facility in New York and you know storage facilities love to give you a cheap couple months to get you in. You know, low price for the first six months. Because nobody wants to move their stuff. They know once your stuff is in that facility, there is a very high switching cost to getting a truck, loading it up, it’s a… It takes time. People will generally stay and then they start hitting you with 10 to 20% price increases every year. Pretty common. Health insurance companies do that too. Anyways, and a lot of these costs are real. If you’re going to learn a new service, that is actually a cost. It requires time. If you’re going to rip out an existing system and put in a new system, often you have to spend money. So there’s a mix of sort of real and perceived costs. When I’m talking about critical as a type of switching cost, that is mostly a perceived risk. There may not be any real costs that we could measure in the short term. Oh, it’s gonna cost me this much money to move my stuff from facility A to facility B. It’s more of a perceived future cost, perceived risk. And people aren’t that rational about risks. You know, the people who make these decisions at these big trucking companies, yeah, they’re pretty rational about buying tables and tires, but when it comes to something that could have catastrophic results, that could cost them their job, right? So people start to think in terms of self-interest when risk is involved. So there’s a lot going on with that whole critical aspect, but it’s a type of switching costs at the end of the day. Let’s see, a couple more examples of switching costs. This is from Hamilton Helmer, who wrote Seven Powers. Some of these are from him, some of these are mine. Financial switching costs. This is when there is a direct monetary cost for switching from supplier A to supplier B. If you have an ERP system you’ve installed, there’s a cost for paying for renewals of your licenses, but there’s also a financial cost if you buy a new system and have to get a whole new system and solved. You could have contractual commitments. If you’re going to break a lease on an apartment you’ve rented, that’s a switching cost. They might charge you a fee. Oftentimes when you’re buying things, you’re buying a durable good at the beginning. If you buy a big printer for your office, there’s an upfront cost to buy the big printer, and then after that you’re paying for maintenance and you’re paying for ink and stuff. That’s kind of the ongoing cost, but if you decide to swap that out, you have to buy a new printer. big durable goods, so that’s a direct sort of durable purchase cost. Another big category would be procedural switching costs. So these aren’t direct costs. These aren’t like, hey, I’ve got to buy a new printer, write the check. This is more like, look, all of our people know this current ERP system, and if we bring in a new ERP system, we’ve got to do a lot of training. That’s an indirect cost. There’s loss of time. There’s loss of productivity. And the interesting thing about this sort of training cost is it actually increases over time. The longer you use a system, the more the switching costs associated with training tends to go up. Durable purchases like buying a big printer, that cost actually goes down over time. If you have a printer but it’s five years old, buying a new one’s gonna be a lot less. Information and databases would be a type of procedural switching costs. You’ve got all your system under this Slack system. You’ve got it under the Microsoft Teams. You’ve got it under the Oracle database. Migrating your database to another system tends to be difficult. That also tends to increase over time as a switching cost. The two I mentioned for WABCO, operational and technological integration. I mean, the people designing these trucks at Toyota are absolutely talking all the time with the people who are designing the brake systems at WABCO. They’re designing them together. Their businesses are to some degree integrated, or at least at the design phase and probably the manufacturing phase, probably the after service parts phase as well. Okay, there’s a lot of this going on in digital right now because things are so easy to connect when it’s just software. So when Alibaba says, hey, we provide digital tools for small merchants, which they do, they call it merchant services. They’re giving all these tools to these small businesses that really become part of their operations. They’re sort of these small companies are starting to build their operational systems integrated with the Alibaba system, which makes it very hard to switch. When a company like Meituan, their primary merchant type that they’re serving is small restaurants for the most part, you know, they’re creating all types of software to give those restaurants. because they want that level of technical and operational integration. Makes it very, very hard to switch. Loyalty programs, any sort of accumulated value, that’s a type of switching cost. You know, it can be, hey, I’ve got so many miles with United. Hey, I go to this coffee shop all the time. I’ve got 15 stamps. If I get 16, I get a free cup of coffee. Pretty much everything you log into now is trying to give you coins or points or something like that. That sort of accumulated value is a switching cost. Relationships. I guarantee you the people at WABCO and the people at Toyota are friends. I guarantee you they hang out. They’re probably in the same town. They’re all engineers. They talk all the time. It’s harder to fire your friend than it is to fire someone who just sends you faxes and you don’t know who they are. So these technical businesses tend to have very strong. personal relationships. That’s a type of switching cause. Companies like McKinsey, Boston Consulting Group, they are as much in the relationship business as they are in the strategy business. They really know these vice presidents of Fortune 500 companies. They all like each other. A lot of them are ex-McKinsey people anyways. The relationships thing, it’s a big deal. Okay, and then the last bucket would be the one I talked about for criticality. which is a real or perceived risk and uncertainty. Yeah, maybe these trucks are gonna have trouble, maybe they won’t, but who knows? And it’s one person in the purchasing office and they don’t wanna lose their job and they’ve always gone with this company and I don’t wanna be the person that says, hey, let’s switch from company A, which we’ve always used, to company B because if something goes wrong, I’m probably fired. Anyways, that’s it for switching costs. It’s super important. I gave you sort of a traditional engineering manufacturing version of it, but it is all over the place in software now, which kind of makes sense if you think about it, that what software and digital do is they make it easy to connect to other things. I mean, the world is becoming more connected. So it’s logical that things are gonna be more connected, integrated operationally and technologically, so switching can become very, very difficult. I’ve said this a bunch of times, try and switch out Microsoft Windows on your laptop. Try and do it. I don’t know how to do it. Okay, and with that, let’s get back to WABCO and I’ll basically give you my take on this. My notes on WABCO, when I, you know, I basically heard Buffett had invested. I went and I pulled the annual report. I went through it, did my checklist, and what I basically came up with is this, which is I like the demand curve. For this product, I like the fact that trucks are made all the time. I don’t think the number of trucks on the road is going to decrease. So on the demand side, it looks to me like a nice long-term secular trend. I don’t see the number of trucks on the road dropping by 50%. I don’t. And that’s pretty common for Buffett, that he likes these stable demand projections. There are going to be a certain number of people on the planet. They all have to drink water every two to three days or we die. Therefore, Coca-Cola is always going to have a certain market for its product, which is basically water with a little caffeine and sugar and it tastes good. This looks the same to me. The number of trucks on the road is not going to go down. They might become EVs, the tech might change, the regulations might change, but the overall demand projection looks pretty stable to me. Okay, well what about the technology and what about the regulations? Well, I mean, this company is based in the EU. What are the regulations regarding trucking and braking in the EU going to be? I’m an amateur at this, but it looks to me like they’re going to be more focused on safety and more focused on being green and energy efficient. That’s probably where that trend line goes. Well, what does WABCO do? They are the safest trucks on the road. They’re the most technologically advanced and they’re efficient. Those are the three qualitative descriptions they use. Okay, that looks like they’re quite well positioned for those two factors. Then we get to my area, which is competitive strength, competitive defensibility. And you know, we know Buffett likes companies with competitive advantages, and this looks like a really strong competitive picture. Number one, it has high switching costs based on criticality. Real and perceived risks are very, very significant. This company’s number one issue is safety. avoiding catastrophic results. And by the way, the thing that they do that is critical, their braking systems are very hard to test. It’s very hard to prove another company can match their level of quality. There’s no FDA that’s going to be able to test the safety of company B’s brakes versus company A over 10 to 15 years. No, you’re going to have to go with the company you know. Oh, and by the way, it’s a very, very hard decision to undo. You’re going to have to make the call. You’re going to have to stick with that company for 10 or 15 years. So I like all of that in terms of criticality. In addition, it looks like there is a decent level of integration in the technology between the truck manufacturers and the braking companies, WAPCO in this case. And it looks like that integration is getting more and more complicated as you go from mechanical brakes to electronic brakes to autonomous vehicles, things like that. Okay, I like that. This also looks like a very small percentage of the cost of a truck. I mean, we know how much truck manufacturers make. These are tens of billions of dollars each. All of WABCO’s revenue is $2-3 billion. So this is a small component in terms of cost. I like that as well. Okay, so we’ve got a great picture in terms of criticality, low cost. Why would you switch? It doesn’t make sense. In addition to that, there’s at least one other competitive advantage here, which is they’re outspending their rivals on technology. They’re one of the biggest players in the market. They’re spending 5% of their cost of their revenue on R&D and tech. That probably makes them the biggest spender on the planet in terms of, I mean, who else is spending more money on breaking technology for trucks than this large player that’s spending 5% year after year after year? And by the way, they’ve been doing this for 150 years. So they’ve got economies of scale with regard to technology related to braking systems for trucks. Someone might match their spending, maybe one or two companies, but for the most part they’re going to be the biggest spender out there. And then the other part that I liked, which didn’t really come up in the annual report, was when you make these sort of systems for the trucks, you also have to support them after the fact. So you need auto shops, in this case truck shops, around the world, anywhere these trucks might be, you need people in those shops that understand your braking system and can fix them. And you need to supply them with parts and servicing. So there is a whole sea of truck… maintenance facilities around the world that is comfortable with WABCO as a technology. That would actually be quite difficult to replace. I mean if you’re a new company, we’re Indian company A, and we go to a EU truck manufacturer and I say switch from your component with WABCO to my components. We make really good braking systems. And let’s say even I can even prove that my technology is as safe. At some point they’re going to say, okay, Can you provide servicing everywhere in the world? Can you supply the parts, the servicing, and are the mechanics around the world familiar with your system? And for a new company or a smaller company, the answer is almost for sure no. So there’s at least three or four competitive advantages I really like within this company. And then you look at your financials and that’s exactly what you see. you see the competitive advantage in their financials. You see the stable market share. You see a 30% gross profit. You see a 15, 13 to 15% operating profit. You see 10% of revenue ending up as free cash flow. Yeah, you’re not getting a huge amount of growth, but it’s a nice, stable cash producing business against a very stable trend, and it looks like a competitive fortress. I like all of that, you know. But. That’s not a big surprise. I tend to get to that same conclusion whenever I look at Buffett companies. And I think that’s really what I wanted to cover. I mean, the two concepts for today, criticality as a sort of key factor in when businesses buy from other businesses. It’s good to keep an eye out for this. And it’s good to take that apart into sort of detailed questions like I did, operational integration, percentage of the cost structure. Is it a reversible decision? All of those things. I find that very helpful. And then the bigger idea of switching costs, of which criticality I think is one type. That’s how I sort of put it in my brain. But yeah, Wobco, it’s a pretty cool company. As for me, I’m having a pretty great weekend. I’m in Mexico City, which is, I mean, it’s one of my favorite places. It’s, you know, it’s up there with Bangkok and New York and Shanghai. There’s certain cities I just really love to go to, and this is on my short list. I try and come here about every year or so. And uh… Yeah, it’s great. And Sundays in Mexico City are fantastic because if you’re downtown, they close off the main boulevards and it all becomes joggers and bicyclists and lots of fruit carts and people making tacos and the park is full of people. Sundays in Mexico City are pretty awesome. So I spent the day walking around and relaxing, feeling a lot better than last week. I’m also sort of powering through this book I’m working on. 50,000 words are done, which is about two-thirds of the way there, I guess. Typical book in English, you know, a full-sized book is about 80,000 words. My recent books have all been about 30,000. I’ve been writing these short one-hour books. But this is, this looks like it’s going to be about 100,000 words. It’s kind of turning into a mammoth thing. So I’ve just been powering through hour after hour in Starbucks in Mexico City. But it’s going pretty well. I think I’ll be done in the next week hopefully and then it’s just endless editing and getting feedback and then some people tell you it’s great but you never really know if they’re just being nice and then some people tell you it sucks and you kind of know they’re being honest so that’s not awesome. But yeah, usually the first draft I find is the hardest phase because that’s when you do most of your thinking. After you get that done, then you’re sort of refining and adding and subtracting, but the bulk of your thinking is pretty much done. So I’ll feel a lot better probably in about a week. Anyways, but it’s been great. And I’m probably going to hang out here for a couple weeks and then it’ll be back to Bangkok, depending on whatever the immigration rules are. They keep changing these rules. I was going to fly into Phuket because they have this Phuket sandbox where you can come in there and you don’t have to quarantine. but you had to fly directly to Phuket, you couldn’t fly through Bangkok. So I was, well, that doesn’t work because I’m flying back to Bangkok. But they changed the rules a couple of days ago and they said, well, now you can fly to Bangkok and just connect. And I thought, well, that’s awesome. But they also changed the rule. And when you get to Phuket, you have to stay there for 14 days, not seven days. They extended it. So now it’s a matter of being quarantined in Bangkok in a hotel room for 14 days or being quarantined on the island of Phuket. but not in a hotel room for 14 days. Those are my current two options and we’ll see what happens next week. I think I’m probably going to Rio for a month and I’ll hang out there, but who knows? Anyways, I hope this was helpful. I hope everyone is doing well and staying safe. If you have any recommendations for anything to do in Mexico City, let me know. I’m always hunting for new, basically, I’m usually hunting for bars and restaurants. But if you have any suggestions, let me know. I know we have some listeners in Mexico, but that’s it for me. Take care and I will talk to you next week. Bye. Bye