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Urbem's 'Quality Strategy' Series: The Competitive Niche

The so-called competitive niche occurs when a company holds the advantage to compete effectively in a specific segment of the market, given its resources and competencies. If that advantage is promising enough to last for the years or even decades to come, then we think that the niche focus could lead to an economic moat. Such a scenario often happens to smaller-scale businesses, as concentrated effort counts a lot when they deal with a narrow target group.


From an investment perspective, we would need to examine the profitability and return on investment to avoid niches that are too specialized or small to generate adequate shareholder value. At the same time, investors should also figure out the business economics that prevent competitors from entering to share the lucrative segment.

Take Tractor Supply (TSCO) as an example. The Tennessee-based company is the largest rural lifestyle retailer in the U.S. and is also the only major player focused on its niche. The leading brand name and nationwide scale of Tractor Supply effectively fends off competition as the industry is highly fragmented and filled with local retailers. In the meantime, relevant retail giants who sell a broader range of products, such as Home Depot (HD) and Walmart (WMT), would have a hard time covering rural locations that are less densely populated, making it difficult for them to compete with Tractor Supply.

Graco (GGG) is another company taking advantage of a competitive niche. The Minnesota-based industrial company is a recognized leader specialized in systems and equipment to manage corrosive, viscous and hard-to-move materials. As approximately 50% of the company's revenue (or 93% of all stock-keeping units) comes from products sold either once or none per day, it does not make economic sense for large conglomerates like Dover (DOV) or Illinois Tool Works (ITW) to enter the market to compete. Meanwhile, Graco has earned a reputation for high product quality over the decades. Customers are quality-conscious in this space, willing to invest in premium products built to last for years of reliable service and keep coming back to the company for parts and accessories for purchased solutions.

We believe that in some cases, it may even require some luck for management to find the right competitive niche, but once there is one at hand, it is crucial to stick to it and keep excelling at it.

For more than 40 years, California-based WD-40 Company (WDFC) sold only one product, WD-40 Multi-Use, a maintenance product based on one single formula that acts as a lubricant, rust preventative, penetrant, cleaner and moisture displacer. It was not until two decades ago that the 66-year-old company started to evolve and gradually expand its offerings, but everything still revolves around its core product, concept and brand. Today, the WD-40 products, including Multi-Use and Specialist, contribute to almost 90% of the company's total sales and are expected to drive the majority of the long-term growth moving forward.

Searching over the Internet, one may have difficulty finding any product that directly competes with WD-40's powerful and secret formula. Shareholders should appreciate the management's niche focus on its circle of competence to deliver low-risk and profitable growth in a moderately-competitive space.

Given the strong advantages granted by having a competitive niche, it should be no surprise that Tractor Supply, Graco and WD-40 all produce consustent industry-beating returns on capital.

Disclosure: The mention of any stock in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We do not own any stock mentioned in the article.

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This article first appeared on GuruFocus.