Acquired
03:25:16 · David Rosenthal, Ben Gilbert
[03:25:16] S1: Let's do it. Seven powers. This will be fun because, you know, Hamilton Helmer's definition of seven powers is what enables a firm to earn sustainably more profits than their closest competitors. And, well, Vanguard, by its very nature, earns no profits. [03:25:35] S0: Right. We're gonna have to sort of adapt the definition of seven powers to really align with more of its spiritual goal. [03:25:41] S1: Why do 50,000,000 people have $12,000,000,000,000 with this business? [03:25:45] S0: Yeah. Maybe it can be expressed through market share instead of through the sum of profits. [03:25:50] S1: Yeah. Why is Vanguard the market share leader in mutual funds and index funds? [03:25:54] S0: Because you can't really talk about it in terms of theoretical profits, because the only thing that earned them the right to exist is not generating profits. So if they were to recognize their theoretical profits, then they may not exist at all, at least historically. Yep. So you sort of have to do the analysis based on market share rather than on trying to estimate what their theoretical profits would be. [03:26:15] S1: Yep. And maybe one little twist on this that we can keep in mind as we go is a question I was asking through the research of what's to stop another idealistic young person from coming along and saying, I also don't care about profits, and I am also going to start another Vanguard and compete with them.
03:26:15 · David Rosenthal, Ben Gilbert
[03:26:15] S1: Yep. And maybe one little twist on this that we can keep in mind as we go is a question I was asking through the research of what's to stop another idealistic young person from coming along and saying, I also don't care about profits, and I am also going to start another Vanguard and compete with them. [03:26:36] S0: What protects Vanguard? That's the question. So the seven are scale economies, network economies, counter positioning, switching costs, branding, cornered resource, and process power. [03:26:49] S1: Yep. Well, to my question, scale economies for sure. [03:26:53] S0: Absolutely. Absolutely. I mean, we said earlier, this business like Costco has scale economies shared. The reason they exist in the first place is because there were not existing low fee index fund providers. If you were to try to start a new one today, in order to break even, you'd probably need one or 2% fees Right. Starting from a zero asset base, so you'd be inherently noncompetitive. You you if if you're not already big or you don't go raise a giant amount of money to subsidize it, then you kinda need Vanguard scale economies to compete. [03:27:28] S1: Put another way, three basis points on $12,000,000,000,000 is still a lot of absolute money that can fund a lot of salaries. [03:27:36] S0: Seven basis points. Place. [03:27:38] S1: So okay. Oh, sorry. Sorry. Seven. Seven. Even more money. Yes. Even more money.
03:27:38 · David Rosenthal, Ben Gilbert
[03:27:38] S1: So okay. Oh, sorry. Sorry. Seven. Seven. Even more money. Yes. Even more money. [03:27:42] S0: So that scale economies. That's that's an obvious one. Counterpositioning. I think this may be the most extreme example of counterpositioning ever. Right. Bogle did something that was essentially noneconomic. There's no economic incentive to create this company in the first place. Their their ownership and fee structure was an advantage that cannot be replicated not only by a a a competitor who would be, like, concerning and destroy their their business, but, like, anyone else who tried to do this would make no money. [03:28:15] S1: Yes. Extreme counter positioning. Now, interestingly, it still took, like, the better part of two decades to get real adoption for this, but I think that's largely because it also took a while for all the mechanisms to Yes. Really get put in place. [03:28:29] S0: I think that's right. [03:28:30] S1: Yep. I don't think there's really network economies here. Nope. There's certainly no switching costs, especially once ETFs are on board. In the traditional mutual fund industry, yes. But ETFs I completely disagree. Eliminate switching costs. Oh, you disagree? You disagree. [03:28:44] S0: There's no chance that I'm gonna sell by Vanguard index fund and realize the capital gains tax only to switch to a different index fund. [03:28:52] S1: Sorry. I was thinking about switching costs in terms of a customer relationship.
03:28:52 · David Rosenthal, Ben Gilbert
[03:28:52] S1: Sorry. I was thinking about switching costs in terms of a customer relationship. [03:28:56] S0: But But that's this kinda unbelievable thing about how if you're a fund manager having someone invested, if they can let the compounding continue unabated [03:29:04] S1: Right. [03:29:05] S0: They should. [03:29:05] S1: Right. Right. Right. And not realize realize the capital gains taxes. Okay. Yep. [03:29:10] S0: Fair point. So I think this is inherent in the fund business model. Mhmm. Mhmm. Especially the open ended public fund business model. [03:29:18] S1: That's a great point. Yep. I do think ETFs meaningfully change this equation for Vanguard, but in a sort of side way, just simply that the customer relationships could now be ported out of Vanguard easily. [03:29:32] S0: Out of Vanguard, the brokerage. [03:29:34] S1: Yes. [03:29:34] S0: But not out of Vanguard, the fund. [03:29:36] S1: Yep. Branding. Branding. I mean, god, the bogleheads, the Warren Buffett endorsements, like, the decades of building the brand. [03:29:44] S0: I'd have to think back to when I first started buying index funds, but I probably picked Vanguard over a Fidelity fund because they both looked de minimisly low fees. And I was like, oh, Vanguard's probably the right thing I'm looking for. [03:29:59] S1: Really hard to replicate Warren Buffett saying that a statue should be erected to Jack Bogle and that he's a hero to the American public and to Now
03:29:59 · David Rosenthal, Ben Gilbert
[03:29:59] S1: Really hard to replicate Warren Buffett saying that a statue should be erected to Jack Bogle and that he's a hero to the American public and to Now [03:30:09] S0: interestingly, there is some wholesale transfer pricing because of the S and P licensing, where the branding is a Vanguard S and P 500 index fund, and Vanguard probably has to pay a good amount of what it makes on that fund to S and P Global. [03:30:26] S1: It's gotta be the biggest single component. [03:30:28] S0: Yeah. Of course. Yep. Process power. There's something unique in the culture at Vanguard. I think people make noneconomic decisions to work there because they're motivated by the mission, and it might also attract a set of people that are not interested in being in New York City finance. [03:30:50] S1: Yep. I think that's totally true.
03:30:50 · David Rosenthal, Ben Gilbert
[03:30:50] S1: Yep. I think that's totally true. [03:30:52] S0: Yep. Cornered resource. I don't think it exists. I don't think so. Alright. That's power. Should we do quintessence? Alright. Quintessence. Here's mine. So we haven't talked about this yet, but I think it kinda comes down to this. Jack had the insight that running a successful mutual fund is actually not a differentiated product. It is a commodity. Yep. What you are seeking is the highest possible long term return on your capital. That is not like buying a unique piece of jewelry. It is like buying a soybean. I mean, this industry that for decades had sort of sold itself on uniqueness, there isn't a unique thing you're seeking. It is just a risk return profile over a long period of time. And so in commodity markets, it is a different set of things that determine a winner versus differentiated product markets. Scale really matters. Brand really matters. And most importantly Low cost. The lowest price is the market clearing price. If someone's selling undifferentiated coffee beans or soybeans or oil for a dollar lower than you are, your demand goes to zero, and they get all of your demand. And he realized that, actually, the public equities investment business is that. And so if you need the lowest price, then you need the lowest cost structure. [03:32:23] S1: I like that. I might suggest a modification. [03:32:25] S0: Please. I'm open to it. [03:32:27] S1: I would suggest that Jack bifurcated the public equities market into commodity and noncommodity. Before Jack and before That's interesting.