One attraction with investing in medium sized companies is the ability to invest in relatively immature businesses which have an attractive growth profile. One such disruptive, high-growth business is Just Eat. Recently, I made the rather bold claim across the desk to my colleagues, that I believed Just Eat was one of the highest (if not the highest) quality medium-sized companies in the UK1. This naturally raised a few eyebrows; after all this business didn’t exist in the UK 10 years ago, and there are a number of other strong contenders for this coveted title. This blog post serves as a defence for that claim.
Defining ‘quality’ is a challenge, one that has been addressed elsewhere by my colleague Jeremy Thomas. I agree with Jeremy’s definition that quality should be defined as a ‘sustainably high return on capital’. A high return on capital is attractive because it means a company generates a high level of profits from a fixed level of investment. Over time, competitive forces can cause a company’s return on capital to fall. Therefore a ‘quality’ company must be able to sustain its high returns. One way to assess a company’s ability to do this is to analyse it through the lense of ‘Porter’s five forces’. These are 1) bargaining power of buyers, 2) bargaining power of suppliers, 3) threat of new entrants, 4) threat of substitute services, and 5) competitive intensity.
Just Eat is a restaurant aggregator. It collects takeaway restaurants on its online site and mobile apps, providing consumers with a wide choice of cuisine for delivery/collection in their local area. Consumers benefit from increased choice, convenience, and price transparency. Restaurants establish an online presence without needing to build and maintain a costly website, no longer need to take phone orders, and benefit from higher order size/frequency. Just Eat charges 10-12% commission on every order, as well as an initial fee for the terminal in the restaurant. There are powerful network effects at play as the whole system becomes more valuable to the consumer, the restaurant, and Just Eat as the network grows.
Let’s take a look at Just Eat through the lense of Porter’s five forces.
Bargaining Power of Buyers: Just Eat ensures that the cost of a takeaway is the same whether a consumer orders through them, or goes direct to the restaurant. Therefore, the buyer bears no visible financial burden by purchasing via Just Eat. As a result, this factor is largely redundant. Just Eat won’t have to suffer pricing pressure from its customers like many businesses, because as far as they are aware, they have no prices to press.
Bargaining Power of Suppliers: Even though the consumer pays for the takeaway, the commission charged by Just Eat is paid by the takeaway restaurant. In my view, the takeaway restaurants have negligible bargaining power. The benefit from increased orders is easily offset by the commission they pay to Just Eat. Last time Just Eat raised its % commission in the UK, less than 10 restaurants left (out of 20,000 in the UK), and half of those came back. If a restaurant left Just Eat in protest of high commission rates, it would likely be to the detriment of their own business, and benefit their competitors who would receive their lost orders. The restaurant takeaway market is also probably too fragmented to see any collective action from restaurants on commission rates.
Threat of New Entrants: Barriers to entry to this industry are low. There are no expensive factories or valuable patents. However the barriers to success are high. One could replicate a sub-scale version of Just Eat, but in order for it to be a success one would need to convince consumers to switch to the service from Just Eat. Why would a consumer who is currently receiving the Just Eat service for free, is familiar and happy with it, ever need to look for an alternative, particularly one which is unlikely to have the same breadth of offer? The challenge is being first to market, and reaching scale quickly so as to deter any new entrants. In most of Just Eat’s markets it is already market leader, so it seems to me the threat of new entrants is low.
Threat of Substitutes: Two possible substitutes would be ordering by phone, or walking into a takeaway in person. But these are inferior substitutes because they are not as easy or convenient. In order to be a threat to Just Eat, a substitute would need to provide a better proposition to the consumer in order to convince consumers to change the way in which they purchase their takeaway. I currently see no new technology that will surpass ordering online in the foreseeable future. But this is clearly a risk to be very aware of should any possible alternative arise.
Competitive Intensity: In established markets where Just Eat is already market leader, the scale and network effects mean competitive intensity is low. In immature markets, where Just Eat is either sub-scale, or one of multiple operators, competitive intensity is higher as many operators seek to become the market leader. In the majority of Just Eat’s markets, it is already market leader. In the rest of its markets, I would expect Just Eat to either acquire the market leader, or dispose of the business. Eventually, this means that Just Eat will only ever operate in markets where competitive intensity is low.
It is difficult to think of many medium-sized businesses in the UK which score so well in this type of analysis. Two strong candidates are Rightmove and AutoTrader, both of which are also aggregators (of properties and vehicles). The very high quality of Just Eat’s business is clearly not lost on the stock market. Indeed, the shares carry one of the highest valuations of any company in the mid cap index. Whilst I am confident in the quality of Just Eat’s business, whether it is a good investment is a question for another post.
1. This is no recommendation to buy or sell any particular security