Stakeholder Value: Exploitation vs Being Taken for Granted

21 September 2020 | by Sean Stannard-Stockton, CFA

“Being taken for granted is an unpleasant but sincere form of praise. Ironically, the more reliable you are the more likely you are to be taken for granted.” — Gretchen Rubin

In our recent post about stakeholder value creation, we discussed the way that the relationship between a company and its stakeholders can be exploitive or value creative. In general, we believe that investors should look to stakeholders themselves to understand the nature of their relationship with the company.

Analyzing stakeholder value creation is not about investors making moral judgements, but rather observing the subjective value that stakeholders themselves believe they are receiving. This is after all how most people think about customer satisfaction. Rather than investors deciding if a company’s service offering is superior or not, they typically look to what customers themselves say.

If a given stakeholder finds the relationship to be value creative, then it likely is, even if we or other third parties doubt that value is actually being created. However, there are times when stakeholders, including customers, may complain about their relationship with a company even while the relationship is highly value creative.

Consider this comic.

(Source: xkcd)

If you are part of the “modern digital infrastructure” how do you view the “random person in Nebraska”? Are you incredibly appreciative that they have been grinding away, solving boring but complex problems for many years so that at very minimal cost you are able to build on top of what they’ve maintained? Or do you view them as holding you ransom and demanding a “tax” or “toll” to maintain their archaic part of the system and thus they are exploiting you?

If the later, is it that the “person in Nebraska” is actually exploiting the providers of “modern digital infrastructure” or instead are you just taking for granted this small but key piece of the systems on which you’ve build your business?

The situation illustrated in the comic is actually quite common. There are many businesses that offer a mission critical product or service on which other companies depend, but which make up a tiny portion of their customers’ overall cost structure.

For instance, in our portfolio today:

  • Mastercard: Along with Visa, this company maintains a mission critical payment system without which the wheels of commerce would grind to a halt. If the Visa and Mastercard payment systems suddenly stopped working, it would cause a global economic crisis.
  • Broadridge Financial Solutions: Essentially all proxy voting is done via Broadridge, the majority of all US fixed income trades are processed by the company, and the majority of top brokerage firms use them to distribute investor communications such as statements and trade confirms. It would trigger a crisis in financial markets if Broadridge were to shut down.
  • First American Financial: Along with peer Fidelity National Financial, the two companies underwrite the majority of residential title insurance policies. Mortgage lenders require that buyers purchase title insurance so that the lenders know that the collateral they are lending against has a clean title. If either of these companies stopped operating it would trigger a crisis in the US housing market.

For relentlessly maintaining critical infrastructure on which a large group of much bigger firms depend, and doing so at a very small portion of the total cost structure, you might imagine that their customers and other stakeholders would celebrate all of the value that is being created. But rather than viewing them as mission critical partners, customers and other stakeholders often seem to take them for granted and complain that everything they do isn’t cheaper, faster, and better.

  • Mastercard: Retailers complain mightily about the fees associated with accepting credit cards (of which Mastercard and Visa earn less than 10%, with the rest going to the big banks). But even while they complain about the fees related to credit cards, many of these same retailers are moving away from accepting cash and pushing their own customers to exclusively making digital payments. This is because there are a large number of indirect costs to accepting cash that makes accepting credit cards a boon for retailer’s businesses.
  • Broadridge: Like other B2B software and service providers focused on a specific industry vertical, Broadridge’s offerings can seem out of date or behind the times. When software is no longer cutting edge, it can cause people to think it should be easily replaced by a more modern competitor. But as the company’s VP of Corporate Strategy Horacio Barakat explained in a recent podcast about them experimenting with blockchain-based technology, the critical value of the types of services Broadridge provides tends to be rooted in their industry specific understanding of the complex, multiple party workflows that are so common in financial services.While legendary activist investor Bill Ackman once called Broadridge’s pricing “extortion” and labeled the company a “bad monopolist”, it is also true that it would cost Ackman far, far more money and time to run a successful activist campaign if Broadridge was not toiling away maintaining a voting system for corporate America.
  • First American: Over the years, First American has elicited interest from hedge funds who think title insurance is a “license to steal”. On the surface, it does seem reasonable to wonder why title insurance is even needed in the first place, since surely the government must keep official records of who owns which property, right?But no, the US government does not maintain a definitive record that can be used to settle disputes about the ownership of real estate. Instead, over the years, a small group of title insurance companies have painstakingly built and maintained a database of this information. And for a price that equates to a rounding error in the cost of buying a home, title insurance enables lenders to extinguish any risk that they are lending against a piece of collateral with uncertain ownership.

In our stakeholder value creation post we argued that stakeholder value is the source of shareholder profits. But it is also true that there is a natural tension between stakeholders that smart management teams need to manage well. All customers would like lower prices. All employees would like higher pay. A company that simply seeks to create value for customers or any other set of stakeholders without regard for the impact on other stakeholders, including shareholders, is going to find the strategy is not sustainable.

The tricky part about running a business is figuring out how to create tremendous value for your customers, even as your employees are thrilled to work for you, your suppliers value your business, and society is either indifferent to your activities or you are actively making the world a better place. And you need to do all of that while doing it all in a way that produces high and sustainable profits for shareholders.

In our last post, we included the example of Fastenal and how the company generated a 40,000% return making it the top performing US stock during the 25 years after the 1987 market crash. We quoted Fastenal’s CEO explaining their strategy this way:

“When I talk about earnings, I’m not talking just about Fastenal, I’m talking about our people, too… it’s not just about growth, it’s about profitable growth, and creating opportunities for your customers and your employees in the process.

I think the mantra is… let’s really hit all pieces and reward all constituencies. And speaking of constituencies, we keep it really simple here. There’s four: There’s customers, there’s employees, there’s suppliers and there’s shareholders. It has to work for all four [stakeholders] for our business to be successful short-term and long-term.”

But generating value for all of your stakeholders is not a naïve activity of just hoping “everybody wins”. Rather it is a complex balancing act requiring top notch management skill and a recognition that decisions like raising prices or laying off employees, have complex, interrelated impacts on multiple stakeholders, both positive and negative.

While we think the best way to evaluate stakeholder value is simply to figure out how each stakeholder views their relationship with the company, it is important to recognize that stakeholders who are accruing a lot of value may, as we described above, take this value for granted and rather than raving about how a company has “thanklessly maintained” some product or service over the years, they may complain that said service should be cheaper, faster or better.

Afterall, everyone always wants just a little more value, just a little lower price, just a little higher salary, just a little more profit. Creating stakeholder value is not a matter of giving away all the value you create, but rather focusing on the complex balancing act of managing value across your stakeholder ecosystem and recognizing that in the end, sustainable shareholder profits are limited by the amount of total stakeholder value you create.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

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