Dhandho 403: Invest in the Copycats rather than the Innovators

Many companies are committed to some sort of innovation, and many investors are looking for the next big innovation that will generate a superior return on investment. However, the author argues that instead of focusing on innovative companies, the investors should rather focus on companies that excel at copying and scaling.

He goes through a few case studies to illustrate his point. Ray Kroc purchased a McDonald's restaurant from two brothers. He didn't invent the concept but saw its potential and developed it. In addition, many of the menu items and processes that made McDonald's the restaurant we see now did not come from the company's headquarters but from its franchisees and other restaurants. McDonald's was successful because it was able to extend the innovations of others.

Microsoft is another company that the author describes as a non-innovator that excels at scaling up the successful innovations of others. Microsoft's inventions often fail, but it is when they take the existing ideas of their competitors and apply Microsoft's know-how that they are the most successful. It took the mouse and graphical user interface ideas from Apple, Excel from Lotus, Word from Word Perfect, networking from Novell, Internet Explorer from Netscape, XBOX from Playstation and the list goes on. In these cases, Microsoft waited for a certain product to illustrate customer acceptance and then went after the proven market.

Pabrai Funds is also a copy of Warren Buffett's funds to a wide degree. From the fee structure to the philosophy of identifying good investments to the reporting system, investor profiles, and staffing structure, Mohnish Pabrai has attempted to emulate Buffett's past partnership.

Too many investors make the mistake of looking for innovators in the stock market. Instead, Pabrai advises focusing on businesses run by people who have repeatedly shown they can enhance and expand on existing ideas.