Two years ago, I investigated the moat around American Express’s (AXP) business. I assessed the moat as wide and identified a positive feedback loop at the heart of it. The loop ran like this:
- Spending on Amex cards is higher on a per-card basis than its competitors
- Merchants want to accept the Amex card to attract these high-paying customers
- This affluent customer pool enables Amex to charge higher discount rates
- Because of the revenues generated from higher-spending Cardmembers, Amex has the cash to invest in more attractive rewards and other benefits to Cardmembers
- The rewards program in turn creates incentives for Cardmembers to spend more on their Cards.
This feedback loop was supported by a mutually reinforcing set of features of the business model: the closed-loop system, the prestige brand image, a spend-centric focus rather than lend-centric, etc. The whole model held together beautifully – until it didn’t.
On February 12, 2015, AXP announced that its 16 year relationship with Costco had ended. Shares of AXP have dropped 24% since that time.
The event triggered the following exchange between a shareholder and Charlie Munger and Gerald Salzman of the Daily Journal Corporation:
Q: I’d like to get your thoughts on American Express [AMEX]. Do you think its moat has narrowed recently?
Mr. Munger: I don’t think it was desirable that it lost its contract with Costco [COST]. Again, that’s an example of what tough capitalism is. Obviously, other people are willing to do it cheaper. It just shows how tough a position that looks impregnable can be in modern capitalism. It’s what makes everything difficult.
To those who already have some money, I think that’s just the way it is, and American Express has had a long period of very extreme achievement and prosperity. I think they’ll have a lot of prosperity in the future, but it doesn’t look quite as easy as it once did. Now, the head guy would say it’s always been hard, he’s been battling hard, but we paddled hard here too, and what good did it do us in Daily Journal’s print business? We paddled like crazy, didn’t we Gerry?
Mr. Salzman: We tried. It was hard.
Mr. Munger: Yeah, what happened is you just keep receding and receding. Welcome to adult life. (emphasis added)
Amex had one of the most durable business models ever designed. Could the good times be over? Continue reading