29. The 1-A-1 Toastmaster - the commoditisation of products
"You do not have to watch it - The Toast can't Burn," read the opening words to the Model 1-A-1 Toastmaster's instruction manual, first printed in 1926. And with that confident, bold-lettered promise, the automatic pop-up, two-sided household toaster was born. The invention's endurance - chances are you used a toaster at breakfast today - is testament to two things: its simple brilliance, and the investment lesson that a product's value eventually diminishes.
The Model 1-A-1 Toastmaster was introduced by the Minneapolis-based Waters-Genter Company. It was designed by Charles Perkins Strite, who seven years earlier had invented and patented the first-ever pop-up toaster used in restaurants, also manufactured by Waters-Genter.
A few tweaks were needed. The Model 1-A-1 had a timer, but, because the filament was slow to heat up, the first slice did not toast completely. What's more, at the time of the first toaster's launch, bread was sold in whole loaves and so needed slicing. It wasn't until 1930 - when Wonder Bread became the first company to start selling pre-sliced loaves - that a mass-market emerged for Strite's home appliance.
Ninety years on, the cutting-edge of kitchen technology has extended to touch-free sensor bins and computerised refrigerators. But the fundamentals of the toaster that are incorporated in the Model 1-A1's design - from the shape to the science behind the heating hardware - are effectively unchanged.
It is this feature that - some 50 years after Mr Strite's invention - led Bruce Greenwald, a professor at New York's Columbia Business School, to remark that "in the long run, everything is a toaster". In his book, Competition Demystified, the value-investment guru was making a simple point: all great innovations, once perfected, eventually become commodities bought on the basis of price and little else. For the early toaster manufacturers, it became harder and harder to attract a premium price with wider adoption, and so making a profit was increasingly about squeezing costs.
For a more contemporary example, consider the price trajectory of Apple's iPod, which retailed for $399 (about £250) when it was first launched in 2001. MP3 players now come as standard on smart phones and tablets. But today if you are determined to buy an iPod or its equivalent you can pick up a Chinese-made version on eBay for £13. Small wonder that Apple stopped making its iconic iPod Classic in 2014.
There should be little surprise that Professor Greenwald, who is arguably academia's leading proponent of value investing, saw the world in this way. As Financial Times columnist John Authers put it, the toaster rejoinder is "a classic put-down by value investors against the overhyped hopes of rival 'growth' investors," who overestimate the long-term profitability of great innovations.
In investment terms, the adage is important for other reasons. First, assuming that a product's price is more sensitive to its customers' perceptions of what it's worth than to the actual costs of making it, then the product has to be continually reinvented and improved to stay ahead of the competition and to keep its customers happy. With the iPod, Apple achieved that feat for 13 years before giving up. Its sixth version - dubbed the iPod Classic - was given its final tweak in 2009 and production stopped five years later. For investors, this obsolescence tightrope has to be incorporated into forecasts, as does a company's ability to constantly innovate.
Second, if everything becomes a toaster in the long run, this underlines the importance of branding and intangible assets. The fact that toasters are still manufactured, launched and redesigned tells us that money can be made out of the product, almost a century after it was first designed. If consumers are given a choice between a staple, relatively cheap item like a toaster, branding might well determine the eventual purchase.
Besides, not everyone buys Professor Greenwald's claim. In a 2007 article, business innovation consultant Michael Schrage argued that the technical evolution of toasters beyond the Model 1-A-1 shows that the kitchen appliance is "a case study of profitable innovation, not just price competition". The presence of differentiation, segmentation and innovation in the toaster marketplace signals that toasters aren't "commodities by any meaningful definition of the word", he said.
Indeed, an internet search throws up an almost comically-wide range of high-end or innovative toasters at various price points. Want to watch your bread as it is toasted through a transparent window? Then you can buy the Magimix Vision Toaster 11526 for around £140. Need a grill slot for a bagel, and need that bagel toasted fast? Then Casa Bugatti's Volo 2-slice, which comes with a 930W power rating and "a touch of Italian flair", should do the trick.
But a product range that includes novel design and high price points does not invalidate the thinking behind The Greenwald Dictum. Sure, there is continuing demand for toasters because they do something useful, in much the same way that vacuum cleaners and steam irons are needed. Such commodities can always incorporate degrees of specialisation, while innovation and changing tastes will create new demands and change the product itself. In that sense, toasters have staying power, which is not to be scoffed at. But, as the Waters-Genter company found out in the decades after the launch of the 1-A-1, the qualities that made the product stand out were soon eroded. As toasters became affordable for all, their prices got lower and lower and the profit margins for making them became thinner and thinner.
30: The 'Shell' telegram - the synergy of mergers
The text is blunt and brief, belying the historical significance of the accord it signals. The date is 23 April 1907 and Henri Deterding, chairman of the Royal Dutch Petroleum Company, has just explained to Sir Marcus Samuel - his counterpart at the Shell Transport and Trading Company - that the two companies have officially merged.
"Meeting approved amalgamation statutes gave full power directors subject to such modifications as might prove revisable or necessary hearty congratulations," reads the unpunctuated, breathless seal of approval in words that would just about squeeze into a single tweet. The formation of Royal Dutch Shell (RDSA) - still one of the largest companies in the world more than a century after the message was sent and read at a Shell board meeting three days later - is possibly the single most important merger in history. In a symbolic sense, Deterding's telegraph also provides investors with several lessons.
First, it is worth unpacking some of the background to the story, which occurred as the world was fully waking up to the power of hydrocarbons. Such was the breakneck pace of the oil industry's growth at the end of the 19th century, the two rivals' combination was somewhat improbable. Royal Dutch was founded in 1890 by Jean Kessler, an entrepreneur and oil explorer who set about developing fields in Sumatra in what today is Indonesia. In its early years, the company had seen some success, and reliable production and cash generation had allowed it to invest in oil tankers and storage facilities. But in 1898, disaster struck: the company's wells started to pump salt water, precipitating a collapse in both production and the company's share price. New resources were desperately sought, and were eventually discovered on 28 December 1899, but the episode had taken its toll on Kessler, who died of a heart attack in Naples while travelling back to the Netherlands the following year.
His replacement, Deterding, was convinced that, in order for the company to flourish and survive in a global market dominated by John D Rockefeller's Standard Oil, Royal Dutch needed to amalgamate with another 'new' oil group. In his seminal work on the history of oil, The Prize, Daniel Yergin writes that Deterding's approach to business could be understood in the Dutch proverb 'Eendracht maakt macht' - unity gives power. "Like Rockefeller," Mr Yergin says of Deterding, "he was repelled by the wild fluctuations in price. Unlike Rockefeller and Standard Oil, he did not want to use price-cutting as a competitive tool; rather, he wanted to work out price-setting arrangements and peace treaties among the warring companies. That was better even for the consumer in the long run, he would argue, because more stable and predictable returns would encourage more capital investment and greater efficiency."
This is what drew Deterding to the much older Shell, which during the 19th century had not only revolutionised oil transportation through the use of bulk tankers, but had built bulk oil storage at ports in the Far East and contracted with the Rothschilds for the long-term supply of kerosene. This had allowed Marcus Samuel's company to dramatically cut transport costs and open up world markets, but also made it a fierce competitor to Royal Dutch. Neither Deterding nor Samuel was prepared to play second fiddle in an amalgamation (first proposed and thereafter pursued by Deterding), and merger talks initially floundered over personality differences and matters of national pride. It was Samuel's need for control that saw him reject a handsome takeover offer from Standard Oil in 1901, and make an alliance with Royal Dutch a year later.
Shell's pre-eminence in downstream began to decline from there. Texas oil supplies had started to dry up, disputes raged within the management team, and Samuel could not convince the British navy to convert from coal to fuel oil. His company was eventually forced into the Royal Dutch union on lesser terms - hence the order of the combined entity's name - after Deterding guaranteed that his firm would buy a quarter of the shares in Shell, and hence keep its best interests at heart. The stock was also originally split 60:40 in favour of the Dutch, preventing a full-scale merger or takeover by one company of the other.
The benefits of M&A are often overhyped, but in the case of Royal Dutch/Shell, the combination created a vertically integrated business which allowed both downstream and upstream segments to flourish. With competition no longer an issue, the former rivals could work together to push down prices and win market share.
Investors should always question the logic of such combinations, which are sometimes sold purely for their scale and mathematical earnings accretion, without a convincing explanation why the two groups would complement one another. Nevertheless, the sheer scale of the business Royal Dutch Shell became is fundamental to its lesson for shareholders. With the exception of recent history, Shell has been an excellent long-term stock for UK equity investors. It has also been a central discoverer, producer, transporter and seller of the most important commodity of the last century. What's more, from its very foundation it was using the cash it generated to reward shareholders and continually expand the business.
Deterding's observation that there was power in a union of the English and Dutch companies was soon vindicated. One lineage of Standard Oil survives today in the form of ExxonMobil, the largest listed oil group on the planet. Were it not for the Royal Dutch-Shell merger, the US company may have ended up swallowing both, forever changing the global distribution of power.
