📖Warren Buffett

Franchise Value

🌳 Advanced★★★★★

A true economic franchise has pricing power, customer loyalty, and no close substitutes.

💬

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.

— Berkshire Hathaway 1991 Letter to Shareholders，1991

🏠 Everyday Analogy

Just like the only convenience store at the entrance of a residential complex—even if its prices are slightly higher, people still buy from it for the sake of convenience. If a street vendor raises prices even a little, customers will walk away immediately. A company with a franchise right is that "only convenience store," possessing pricing power and customer stickiness.

📖 Core Interpretation

Economic Franchise vs. Ordinary Business: A franchise can make mistakes and survive, while an ordinary business will die if it makes mistakes.
💎 Key Insight：Buffett distinguishes between a commodity business (competing on price) and a franchise (competing on value). A franchise satisfies three tests: the product is needed, customers see no close substitute, and pricing isn't regulated. Franchises like See's Candies or Coca-Cola can raise prices regularly while maintaining customer loyalty — that's pricing power in action.

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❓ Why It Matters

All three conditions are indispensable: essential/desired, no substitutes, and free from price controls. Only when these three conditions are met does a franchise exist.

🎯 How to Practice

Test question: If this company raises its product prices by 10%, where will its customers go? If there is nowhere else to go, it possesses a franchise.

🎙️ Master's Voice

An economic franchise arises from a product or service that: is needed or desired, is thought by its customers to have no close substitute, and is not subject to price regulation.
Coca-Cola is an economic franchise. No other cola can replicate its brand. Customers actively seek it out. It can raise prices. Compare this to a commodity like corn—any seller can provide it, price is set by the market. Buffett seeks franchises, not commodities.

⚔️ Practical Guide

✅ Decision Checklist

  • Do customers have a strong preference for this product?
  • Are there close substitutes?
  • Can the company set prices independently?
  • Is demand stable through economic cycles?

📋 Action Steps

  1. Assess brand strength and customer loyalty
  2. Identify potential substitutes
  3. Evaluate pricing independence
  4. Test franchise durability over time

🚨 Warning Signs

  • Commodity-like products
  • Price competition with substitutes
  • Regulated pricing
  • Cyclical demand

⚠️ Common Pitfalls

✕A brand is a franchise - A brand is merely one source of franchise value, and other conditions must also be met.
✕Franchise rights are perpetual - though they may be eroded by technological changes (as seen in the newspaper industry).

📚 Case Studies

1
Coca-Cola (1988)
Meeting Three Conditions
✨ Outcome：One of the World's Strongest Economic Franchises
2
Newspaper Industry (1991)
Previously held a franchise (local monopoly).
✨ Outcome：Eroded by the Internet
3
Power Company (1991)
Essential and Irreplaceable
✨ Outcome：However, due to price controls, it is not an ideal franchise.

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