WHATEVER FLOATS YOUR MOAT
Bigger is not necessarily better when it comes to digging an economic moat. It is very easy to assume that a company with high market share has a sustainable competitive advantage—how else would it have grabbed a big chunk of the market? But history shows us that leadership can be fleeting in highly competitive markets. Kodak (film), IBM (PCs), Netscape (Internet browsers), General Motors (automobiles), and Corel (word processing software) are only a few of the firms that have discovered this.
In defining an economic moat, what should you look for? There’s a couple of types of moats that have been proven to last the test of time. Here’s your list:
Types of Economic Moats
- Intangible Assets: A company can have intangible assets, like brands, patents, or regulatory licenses that allow it to sell products or services that can’t be matched by competitors.
- High Switching Costs: The products or services that a company sells may be hard for customers to give up, which creates customer switching costs that give the firm pricing power.
- Network Effect: Some lucky companies benefit from network economics, which is a very powerful type of economic moat. It says that the more people you have on your platform or in your distribution system, the better the value for them, which creates a virtuous cycle.
- Low Cost Advantage: Finally, some companies have cost advantages, stemming from process, location, scale, or access to a unique asset, which allow them to offer goods or services at a lower cost than competitors.
These four categories cover the vast majority of firms with moats. Now that you know them, you can begin to identify them. They are used by the best stock investors to identify great companies.
ESSENTIAL QUESTIONS TO DISCUSS:
- Name one business that you think has a “wide moat”? (one that is unlikely to have its competitive market position eroded 10 years from now).
- Name one business that you think has a “narrow moat” (one that has a good business today, but whose high returns are unlikely to last 10 years from now).
- Name one business that you think has “no moat” (one that is a highly competitive, bad business today and in the future as well).