The Helmet Shop Outside the RTO: When the Law Sends the Customers, Who Keeps the Profit?

The helmet shop outside the RTO

Outside almost every regional transport office (the RTO, the government office where vehicles are registered and driving licences issued) in India, there is a row of small shops. They sell helmets, number plates, reflective tape, first-aid kits and the little tools the rulebook says a vehicle must carry. Nobody walks into these shops because they woke up wanting a helmet. They walk in because the law says they must have one, and the office across the road will not finish their paperwork until they do.

It looks like the perfect business. The customers arrive without being asked. They do not haggle much, because they are in a hurry. The demand will exist next year and the year after, for as long as the rule exists. And the shopkeeper did not have to create any of it. A government did.

Now look again. There are eleven shops in that row, and all eleven sell the same helmet at almost the same price. None of them is rich. The rule that sends the customers sends them to every shop on the street equally. The law made the demand. It did not make anyone a winner.

This letter is about that second look. A surprising number of listed businesses in India and around the world have customers who are sent to them by a rule: a law, a regulation, a licence condition, a school circular. Investors often treat that as a moat (a durable advantage that protects a business from competitors, like the water around a castle). Sometimes it is. More often it is a river that flows past everyone’s door. The skill is telling the two apart.

What it really means

Think of a kirana shop (a small neighbourhood grocery store) beside a school. One morning the school sends home a circular: every child must bring a particular brand of notebook, a particular blue ink, and a particular water bottle. The next day, the kirana shop is full. The owner did nothing to earn this. The school made the customers.

Three things can now happen, and each tells you something different. If the school named the shop, so that parents must buy from this shop and no other, the owner has been handed a small monopoly (a market with only one seller). If the school named the product but not the shop, every kirana in the neighbourhood will stock that notebook by the end of the week, and the owner’s advantage will last about six days. And if the school also fixed the price at which the notebook must be sold, the owner has plenty of customers and no say at all in what they pay.

That is the whole framework, and it comes down to three questions. Who made the demand? Who else is allowed to serve it? And who sets the price? A business where the answers are the state, only us, and we do can be one of the best businesses on earth. A business where the answers are the state, anyone, and the state is a utility (a business, like a water supply, whose prices and returns are controlled by the government) dressed up as a moat.

Warren Buffett has spent sixty years asking the third question above all others. In 2010, when American investigators interviewed him about the credit rating agencies (companies that grade how safe a bond or a borrower is), he said something that is worth reading twice: the single most important decision in evaluating a business is pricing power. If you have the power to raise prices without losing business to a competitor, you have a very good business. If you have to hold a prayer session before raising the price by a tenth of a cent, you have a terrible business. Demand that arrives by law can sit on either side of that line. The law only guarantees that the customers come. It says nothing about what they will pay, or whom they will pay it to.

Why it works

Why is demand made by a rule so often weaker than it looks? Three reasons.

First, a rule is public. When a business builds demand the ordinary way, with a better product, a trusted name, or a shop on the right corner, its rivals have to work out how it did it. When demand comes from a rule, everyone can read the rule. The notice that sends a million customers to buy something is the same notice that tells a thousand entrepreneurs to start selling it. Rule-made demand invites rule-made supply, and it invites it fast.

Second, the hand that makes the demand can also cap the price. Governments do not make people buy things in order to enrich the sellers. They do it for safety, or trust, or revenue. Once a purchase becomes compulsory, the buyer has no way to walk away, and the state knows it. So it very often steps in to fix the price, or to cap it, or to license the sellers on condition that they charge no more than a set amount. The customers are guaranteed. So is the ceiling on what you can earn from them.

Third, the rule can be changed by someone who does not own your shares. A moat built on a brand, or on a cost advantage, or on a habit, erodes slowly and visibly. A moat built on a paragraph in a government notification can be widened or removed in a single afternoon, by people whose job is to serve the public rather than the shareholder. That does not make the business bad. It does mean that its most important asset lives in somebody else’s filing cabinet.

Put the three together and you get the lesson. Compulsory demand tells you the customers will come. It tells you nothing about the quality of the business. Quality is decided, as it always is, by what happens after they arrive: whether the company can serve them at a lower cost than anyone else, whether it can charge more than anyone else, and whether anyone else is allowed in at all.

A real example or two

Start with gold. In June 2021 the government made hallmarking (an official stamp certifying the purity of gold jewellery) compulsory in 256 districts, and extended it to 343 districts by September 2023. Overnight, every jeweller in those districts had to send every piece to an assaying and hallmarking centre before selling it. Demand for hallmarking, which had been optional and thin, became enormous and permanent. If you had owned a hallmarking centre in 2021, the customers would have arrived by law.

So would the competitors. There were 943 hallmarking centres in the country when the rule came in. By September 2023, according to the ministry’s own figures, there were 1,471, and the number of registered jewellers had risen from about 35,000 to about 1,82,000. The rule created a flood of demand and, within two years, a flood of supply to meet it. The hallmark itself is standard; the fee is small and much the same everywhere. It is a necessary, useful, low-margin trade. It is the helmet shop outside the RTO.

Now motor insurance. Section 146 of the Motor Vehicles Act says that no vehicle may be driven in a public place without third-party insurance (cover for injury or damage you cause to someone else). Every vehicle on every road in India is therefore a compulsory customer of some insurance company. But the premium (the price of the policy) for this compulsory cover is not set by the insurers. It is notified by the government, in consultation with the insurance regulator. In June 2022, for example, the rate for a small car was fixed at 2,094 rupees, after being held at 2,072 rupees through the pandemic years. The insurers have often complained that in some vehicle categories the claims they pay exceed the premiums they are allowed to collect. Guaranteed customers, capped price, dozens of licensed sellers. That is the third answer in our framework, and it is not a moat.

Compare the credit rating agencies. In much of the world, banks, insurers and pension funds are required by regulation to hold bonds that carry a rating, and for decades two firms, Moody’s and Standard and Poor’s, were the ratings the regulators recognised. In his 2010 interview, Buffett described the result. Moody’s had, he said, huge returns on tangible assets, almost infinite. It was a natural duopoly (a market with only two sellers), assisted by the fact that the two of them had become a standard for regulators. Anybody coming in and offering to cut the price in half had no chance of success. And then he added the line that every investor should remember. Berkshire, he said, was a customer of Moody’s too: an unwilling customer, but a customer nevertheless. Here the rule made the demand, the rule limited the sellers, and the sellers set the price. That is the first answer in the framework, and it made one of the most profitable businesses of its era. Buffett was careful to add that this position could change. He was right to be careful.

One more, because it shows the middle case. In almost every American state the law requires drivers to carry insurance, so every car insurer in the country has customers sent to it by law. That did not make them all wonderful. What made GEICO wonderful, and what drew Buffett to it as a young man in 1951, was that it sold directly to drivers instead of through agents, so its costs were far below its rivals’. By 1995 its operating expenses were about 24 per cent of the premiums it collected, a level Buffett said virtually no competitor could match. The law sent the customers to everyone. A cost advantage decided who kept them.

To be clear, nothing here is a comment on any of these companies’ shares today. They are stories about a pattern, and the pattern is the point.

How you can use it

When you find a business whose demand comes from a rule, resist the first reaction, which is relief. Ask five plain questions instead.

One. Who wrote the rule, and could they unwrite it? Find the actual law, notification or licence condition that sends the customers. Note how old it is, and how many times it has been amended. A rule that has been tightened steadily for thirty years is a different asset from one introduced last budget.

Two. Who else is allowed to serve the demand? Count the sellers. If the rule names the product but lets anyone sell it, expect the hallmarking pattern: a rush of new entrants until the profit is ordinary. If the rule limits the sellers, by licence, by capital requirement, or by naming a standard that only a few meet, you may have something rarer. Check whether the number of licensed sellers has been rising.

Three. Who sets the price? This is the question that separates a moat from a utility. Read how the company’s prices are decided. If a regulator notifies them, or caps them, or must approve every increase, then however many customers arrive, the return on capital (the profit the business earns on the money invested in it) will be decided by that regulator, not by the company. Look at the history of price changes: were they granted grudgingly, late, and after losses, as with motor insurance, or does the company raise its own prices quietly every year?

Four. What does the company do beyond the compulsory bit? The best rule-fed businesses use the compulsory customer as a doorway. The insurer who must sell you third-party cover may also sell you cover for your own car, at a price it sets. The auditor the law requires may also be hired for advice. If a company earns its real profit on the optional part and merely breaks even on the compulsory part, its quality lives in the optional part, and you should judge it there.

Five. Would the customers come anyway? This is the deepest test. Imagine the rule were repealed tomorrow. Would people still buy? A business whose product people would want without the law, and which the law merely makes universal, has two engines. A business whose product nobody would touch without the law has one, and it belongs to the government.

One last thought. Rule-made demand is not a flaw. Some of the finest businesses in history have had it, and so have some of the dullest. What it is not is a substitute for the other lenses we have written about in these letters: whether the company earns a high return on the money it uses, whether it keeps costs low, whether its profits turn into cash, and whether the people running it treat your money as their own. The law can fill the shop. Only the business decides what is left in the till at closing time.

Key takeaways

• The law can make customers; it cannot make winners. A rule that sends a million buyers to a product sends them to every seller of that product equally, unless the rule also limits who may sell.
• Three questions decide everything. Who made the demand, who else may serve it, and who sets the price. State, only us, we do is a moat. State, anyone, the state is a utility.
• Rule-made demand invites rule-made supply. Hallmarking centres rose from about 940 to nearly 1,500 in two years after the mandate, and registered jewellers rose fivefold. Public rules are public to competitors too.
• The hand that makes the demand can cap the price. Compulsory third-party motor cover has guaranteed buyers and a government-notified premium; the rating agencies had guaranteed buyers and set their own price. Same kind of demand, opposite kind of business.
• Ask what would happen if the rule vanished. A business people would use without the law has two engines. A business nobody would touch without the law has one, and it belongs to the government.

— Manish Goel · multibaggershares.com

Manish Goel

Manish Goel is a Chartered Accountant and the Founder of Multibagger Securities Research & Advisory Pvt. Ltd. (SEBI Registered Investment Adviser, INA100007736). A full-time value investor since 2010, he has helped thousands of investors build long-term wealth through quality stock picking and disciplined fundamental analysis.

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