Companies exploiting the network effect build platforms for success
A professional investor tells us where he’d put his money. This week: Eric Burns, fund manager at Sanford DeLand, highlights three favourites
An excellent source of investment ideas for us over the years has been “platform businesses”. These often simplify or enhance their customers’ proposition in return for a fee. Platforms tend to be very scalable and have relatively fixed costs. As a result, a large proportion of any increase in revenue is converted straight into profit. Some possess what we consider to be the holy grail of investing: a network effect.
A network effect, simply put, refers to goods or services that grow in value the more people use them, thus attracting more people, in a virtuous circle. Platforms boasting network effects are fairly rare beasts, but we own a number of them in both the CFP SDL Free Spirit and CFP SDL UK Buffettology funds, which aim to buy high-quality businesses and hold them for the very long term.
Making all the right moves
Perhaps the best example we own is Rightmove (LSE: RMV), which has a market capitalisation of £4.3bn and is held in the Buffettology Fund. It is the leading UK property portal by a mile.
Virtually all estate agents list their properties on it, which in turn means every househunter uses it to find their next home. Estate agents pay a monthly subscription per office to list their properties.
At the end of December 2023, Rightmove had just over 19,000 advertisers paying them an average of £1,431 a month, a figure that has grown at a compound annual rate of 7% over the past five years, which included Covid. What is Rightmove’s “moat”, or enduring competitive advantage? Can you imagine listing your house for sale with an estate agent that’s not on Rightmove?
Another example is Auto Trader (LSE: AUTO), worth £6.4bn, which has been held in the Free Spirit Fund since 2018. Auto Trader is to the vehicle market what Rightmove is to housing, with British car buyers spending roughly ten times as many minutes on the platform as on the group’s nearest rival’s site.
In consequence, advertisers have to be listed on Auto Trader as that’s where the customers are, and the reverse is also true. More than 13,000 retailers’ forecourts use the platform and pay Auto Trader an average of £2,683 per month.
The final example, Auction Technology Group (LSE: ATG), with a market value of £686m, is a recent addition to the Free Spirit Fund. ATG does exactly what it says on the tin, owning a collection of eight online marketplaces serving auctioneers in areas ranging from arts and antiques to industrial and commercial.
Rather like eBay, it charges a fee for auctioneers to list their consignments, along with a success fee if it introduces the winning bidder. The auctioneer market is highly fragmented and for all but the largest participants it makes sense to pay away a small portion of their commission for access to a digital marketplace, rather than invest in their own.
Again, the more buyers the platforms have, the more attractive they become to ATG’s auctioneer customers, which in turn drives more buyers. ATG is different from Rightmove and Auto Trader in that it is an amalgamation of several marketplaces (both in the US and Europe) rather than just one.
But each is a leader in its chosen segment. Being market leader is absolutely critical as online platforms and marketplaces typically exhibit “winner-takesmost” characteristics over the long-term.
“British car buyers spend ten times as many minutes on Auto Trader as on its nearest rival’s site”