Among the many investment books I have read, only a few have inspired me enough for me to write about them in some detail.
One of them would be The Investment Checklist by Michael Shearn. He serves on the investment committee of Southwestern University, which oversees the school’s US$250 million endowment, and is also a member of the advisory board for the University of Texas MBA Investment Fund.
In a previous article, I covered the first segment of Shearn’s checklist: “Understanding the Business – The Basics.” The second segment of the comprehensive checklist includes questions on understanding the business from the customer’s perspective. Remember that although these questions serve to enhance our understanding of a business as investors, they should also be used in conjunction with other frameworks for investment analysis. There are eight questions in total in the second segment, but I will focus on the first four in this article, with the next four appearing in a future article.
1. Who is the core customer of the business?
When evaluating a business, it’s important to know the types of customers the business is serving. Is it a B2C (business to consumer) or a B2B (business to business) model? This can have implications for our analysis of a company as a B2C business generally has customers that are more fickle and less loyal than a B2B business. It’s also useful to define the demographic of the customer if possible for a B2C business: Age, race, gender and income levels are some examples. For a B2B business, try to find out which section of the supply chain it serves, and also the general profile of the customers.
2. Is the customer base concentrated or diversified?
This question links back to the Porter’s Five Forces analysis framework which I wrote about recently. If a company has few customers (which would mean a concentrated customer pool), then the customers would exert more bargaining power against the company. The company would face a tougher time trying to raise prices. If the customer base is very dispersed and diversified, the company would find it easier to raise prices or tweak its product mix as the customers have less bargaining power.
3. Is it easy or difficult to convince customers to buy the products or services?
Some products and services are niche and specialized and it may be tough to convince people to buy them. An example might be a high-end coffee machine which can brew wonderful coffee, but which comes at a very high price. Most people would settle for a reasonably-priced coffee machine or simply buy coffee from a convenient coffee joint if they wish to consume a cup of java, therefore it may take a lot of effort to convince customers to spend on an expensive product. Investors should review a company’s suite of products and services to assess how easy or tough they are to sell.
4. What is the customer retention rate for the business?
One of the most important aspects of serving customers is ensuring that they are satisfied, and that they come back for more. Happy customers not only make repeat purchases, but they also convince other people who are not customers to eventually become loyal customers (through word of mouth), so this has a positive virtuous cycle effect. It is also much cheaper for a business to retain customers than to acquire new ones.
Click here now for your FREE subscription to Take Stock Singapore, The Motley Fool’s free investing newsletter. Written by David Kuo, Take Stock Singapore tells you exactly what’s happening in today’s markets, and shows how you can GROW your wealth in the years ahead.
The Motley Fool’s purpose is to help the world invest, better. Like us on Facebook to keep up-to-date with our latest news and articles.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.