Editor's Choice

This Company Is Building Monopoly Power

Jordan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The best businesses are those that have implicit monopoly power. They can earn high returns on capital without sacrificing quality to beat their customers on price. Implicit monopolies aren't constrained like explicit monopolies, either.

This rapidly-growing dot com is slowly building an impenetrable monopoly.

Bank on printing

Vistaprint (NASDAQ: VPRT) is a leader in the online printing space. The company offers inexpensive products meant for business customers. From promotional pens to business cards and letterhead, the company uses its scale and pricing to beat out local competitors for a greater share of the promotional market.

Vistaprint has found its niche in “microbusinesses,” which are small, often one-man startups that need essential supplies for a small office. Microbusiness owners can purchase everything they need at Vistaprint to make their one-man shop look as official as a multinational corporation.

This fast-growing niche rewards the company with impressive top-line growth. In the quarter ended March 31, 2013, the company reported revenue growth of 12% year-over-year in constant currency terms, while projecting full year growth of 17% year over year.

At nearly 200,000 orders per day in the second quarter, Vistaprint is a sure leader in the space. It’s also maturing. The company reduced its aggressive cross-promotional marketing to invest in the consumer. Customers were turned off by the company’s non-stop email campaigns and checkout upsells, which it has since removed from the site. The move should help retain customers who simply want a simple step-by-step purchase of necessary office supplies.

Massive bottom line growth potential

Vistaprint operates in a very competitive industry. Open your local phone book or search Google for promotional companies near you – you’ll find hundreds in a city of any true size.

With competition comes margin compression. The biggest cost this industry faces is the cost of customer acquisition. Financial supplements reveal that as a percentage of revenue, marketing and selling costs are higher than the cost of each product.

The high cost of customer acquisition may soon level off, however, as the company’s growth phase ends and repeat orders make up significantly more of its quarterly revenue. Here’s a chart of its advertising costs and cost of customer acquisition over time:

<img alt="" src="http://g.fool.com/editorial/images/55889/vistaads_large.png" />

The company’s investments in its customer may soon pay off, however. In another slide, Vistaprint reveals that its type-in customers (those who go directly to the site by typing the domain name into their browser) are a rapidly-growing portion of its customer base.

<img alt="" src="http://g.fool.com/editorial/images/55889/vistaprintmarketing_large.png" />

As more customers come to the site via direct type in, its advertising costs should plummet, leading to rapidly growing margins. Remember, advertising takes 25 cents of every $1 of the company’s revenue. If in five years its marketing could be cut by 20% (hardly a big change, given the large share of search spending in its budget) the company’s income from operations would more than double.

Not to mention, its repeat customers spend substantially more per order than its new customers ($98 vs. $50 in the first quarter of 2013).

Growing in brick and mortar locations

Vistaprint isn’t just an online company. The ability through which executives have formed long-lasting, market share-stealing partnerships is exceptional. Vistaprint quietly receives outsourced projects from Staples (NASDAQ: SPLS) and FedEx Office. A partnership with Staples is a sign that Vistaprint can beat the pricing power of a worldwide office supply store with more than 2,000 retail stores.

Staples needs all the help it can get in a languishing market for brick and mortar office supplies. By partnering with Vistaprint, it can push off necessary capital investments while offering a range of printing services to its customers. Consolidation in the industry may help Staples fend off competition in the market for business supplies to massive multi-national companies, but small businesses have a multitude of choices. Amazon, Wal-Mart, Target, and other stores sell necessary office supplies at lower prices, all of which can ship products to customer's doors.

The partnerships couldn’t be better for Vistaprint. The company taps into a network of thousands of office supply stores around the country for local delivery. In essence, the company can use someone else’s stores to sell their wares at no cost to the company.

These strategic partnerships put even more strain on the company’s local competitors, while providing FedEx Office and Staples with a greater selection of business products to draw in new customers.

Why I’m a long-term bull on Vistaprint

Vistaprint is in the mix of a bitter, very price competitive business. The only way to win a price-competitive, commodity business is to do it on price. That typically sends me running, but a few companies can pull it off without destroying shareholder value.

There is only one way to generate above-average returns on invested capital and compete on price: have the scale to best competitors. Wal-Mart (NYSE: WMT) is a perfect example of a company that operates in a commodity business (retail sales) but won its market because it has the best selection at the best price. Wal-Mart could source products less expensively, leverage national advertising to build its brand (which regional grocers could not) and compete on price to steal competitor’s customers.

Wal-Mart is using its scale to invest in its customers. The company announced as much as $6 billion in price cuts to stay competitive through 2017. While such a move might bankrupt smaller grocers and superstores with thinner margins and significantly lower volumes, Wal-Mart's effective monopoly and wide moat allow it the convenience to invest in price cuts and maintain profitability. At less than 14 times future earnings expectations, Wal-Mart is worthy of an investment due it its monopolistic position.

Vistaprint is the Wal-Mart of microbusiness supplies and promotional materials.

Where small print shops do have the capacity to print low volume orders, they cannot do so cost-effectively. Local printers have high fixed costs, low operating efficiencies, and expensive direct sales overhead that force them to target mid-sized businesses in their geographic region.

Eventually, I wouldn’t be surprised to see small print shops close their printers to work as a direct sales force for Vistaprint. That bodes well for investors, who can grab a piece of a fast-growing business ready for persistent, double-digit annual growth.

Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends Vistaprint. The Motley Fool owns shares of Staples. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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