Investors might think the purpose of a company is to continually maximize profits, but the process of deliberately lowering short-term profits to invest in a brand can sometimes create enormous value over a longer period of time. This “capacity to suffer” during a period of heavy investment (a phrase I borrow from Tom Russo) is also a sign of a differentiated management team, something Andvari is always eager to discover.
From Sleepy to the Super Bowl
A well-known example is car insurance company GEICO. After Warren Buffett’s Berkshire Hathaway purchased GEICO in 1996, money became no object when it came to growing the business. Prior to that, GEICO had relatively lower ambitions. In 1995 it only spent $20 million on advertising. This figure would grow to over $1 billion of annual spend in 2012. Along the way, the company introduced us to the GEICO Gecko® in 1998 as well as the memorable Caveman, who arrived in 2004 to emphasize that using GEICO.com was “so easy even a caveman can do it.”
The GEICO Gecko®
As a result of the enormous spending to build its brand (in addition to a strong emphasis on customer experience), GEICO went from less than 3% market share in 1995 to over 13% as of 2019. Buffett’s prized float stemming from GEICO (the premiums that it receives from policyholders which it hasn’t yet paid out in claims) increased from $2.5 billion to $22.1 billion in 2018, a near ten-fold increase. By Buffett’s account, although spending billions on advertising dampened reported profits (and continues to be a major fixture in the company’s expense line), GEICO’s growth helped increase Berkshire’s intrinsic value by more than $50 billion.
Trashing Margins to Build Bigger
CoStar Group is a more timely example of a company spending heavily to take market share and strengthen its long-term position. In 2014, CoStar purchased the online apartment rentals company Apartments.com for $585 million. The sellers were a collection of large newspapers that were likely maximizing for profit, not growth. One of the first things CoStar did was to increase the site’s sales force from 85 to 140. CoStar also redesigned the web site to enhance the user experience for both renters and owners of apartments.
Like GEICO, the most important decision CoStar made was to invest heavily in building a brand. In 2015, CoStar would invest an additional $75 million on top of the advertising Apartments.com was already spending. The ad campaign would feature Jeff Goldblum as Brad Bellflower, a Silicon Valley maverick and inventor of the “Apartminternet”, showing renters a better way to find an apartment. By the end of 2017, CoStar had invested a cumulative $300 million into building Apartments.com’s brand. In 2020 alone, CoStar will spend $250 million on advertising.
Golblum as Apartment.com’s Brad Bellflower, inventor of the “Apartminternet”
Realizing Market Leadership
The initial results from this strategy were excellent. Apartments.com had more than 7 million unique visitors to the website in March 2015, more than double the prior year. Fast forward to 2019, after nearly $1 billion of investment in advertising and the acquisition of two other rental websites, Apartments.com now averages over 20 million monthly unique visitors. This put Apartments.com ahead of competitor Zillow Rentals in terms of monthly unique visitors. Unaided awareness of the Apartments.com brand was at 16% before the launch of the branding campaign. Now it is more than 35% according to CoStar.
From the chart below, you can see CoStar’s company-wide margins tanked from 30% to nearly zero during the initial period of heavy brand building, but the financial results have borne out nicely. CoStar’s revenues from its multifamily segment have grown from $26 million in the first quarter of 2015 to $145 million in the second quarter of 2020. Company-wide margins have rebounded to their original highs.
CoStar Group Tanks Margins to Grow Business for the Long-Term
Buffett’s full control over GEICO allowed it to invest heavily to gain market share. There were no Wall Street analysts or short-term traders crying ‘foul’ at new expenses hitting the bottom line. In CoStar’s case, the founder and CEO Andy Florance is still in charge, which gave him the power and the perspective to invest heavily in this new business. Since 2015, CoStar’s share price has increased from the $170 range to over $800 per share.
There are few public company CEOs that have the leeway to take margins down to zero in exchange for growing the business over the long-term. Knowing what GEICO achieved with its heavy investment, Andvari knows to study those companies and their leaders who have the ability and tenacity to make those tough investment decisions.
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