As investment advisors who build portfolios filled with individual stocks, we are always on the hunt for the best company within a desired industry. For example, if you had interest in Internet Search you most likely invested in Google at some point and hopefully, not Yahoo. Sure, there are other industry competitors that will survive and prosper alongside Google, but probably not at their level. Google is the champ so not a bad position to be in, right? But what if there is a more powerful position to be in; especially from an investor’s point of view? Let me introduce you to the duopoly.
Applying the same thought just outlined as we search for individual companies to invest in, landing on the two “best” companies in an industry is even greater. Obviously, we have now found not one but two companies to invest in, but the real value here is in the combined companies. Quite simply, when two great established companies dominate an industry, it leaves little to no room for a true third competitor. Therefore, as long as the firms forming the duopoly have great management, operate in a solid industry, and most importantly, participate in rational pricing philosophy, it is going to be a challenge for a third company to make serious inroads into this industry.
Two well-known industries that have historically been dominated by two companies are Freight Delivery and Home Improvement Retail. In this chart to the right you can see UPS and Fedex make up over 80% of parcel shipping. Combined, they have a dominant position. Now, what if UPS didn’t exist and Fedex still had 30% market share? There would be 50%+ filled with smaller competitors who all believe they can grow market share creating a much more competitive landscape ultimately resulting in a less compelling investment (from our perspective).
The other example is Home Improvement Retail. In this chart you can see Lowe’s and Home Depot with a combined 72% market share. Again, this leaves very little room for a serious third competitor. In any of these duopoly industries the one strong barrier to entry is the capital investment it would take to build a meaningful business. So, when you look at your more capital-intensive businesses, like these two we’ve highlighted, the risk of another serious competitor is even slimmer.
One last fact we have seen with successful duopolies is that both participants have somewhat stayed out of each other’s way in the early years. For example, in the Freight Delivery industry, UPS was built on their ground shipping business and when Fedex came along many years later, they focused on air freight shipping. This allowed both to grow to sizeable companies where now they compete in both business lines.
In summary, as investors, it is not imperative we buy both companies in the duopoly, but it is definitely noteworthy to understand the duopoly itself may very well be the most valuable asset in an investment in either company.