“In general, if any branch of trade, or any division of labour, be advantageous to the public, the freer and more general the competition, it will always be the more so” – Adam Smith, The Wealth of Nations, 1776
As investors, we spend the majority of our time analysing companies that compound economic value. A company that is able to generate sizeable profits, sustainably, over a period of time, is often attractive from an investment perspective, but what allows a company to earn money over and above its cost of capital? And more importantly: what allows that to remain the case for years, often decades? Economic theory dictates that an industry where supernormal profits can be earned becomes vulnerable to new entrants. Therefore, these profits will be eroded by competition over time.
This has certainly been the case throughout history. Nokia is a prime example: previously dominant in the mobile phone industry for several decades, new entrants came in with innovative functionalities and made its technology redundant.
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