Well, this isn’t the next part of the Harry Potter Series (Beasts are way less fantastic) but Economic Moat as popularized by the Oracle of Omaha, Warren (the overrated) Buffett is a sustainable competitive advantage that is difficult to duplicate or emulate by would be competitors which separates certain companies that strive for years from the ones that flounder.
It is that broad ditch which surrounds your corporate fortress and lets you think that you will be able to buy your (cheap jack) bagel on every office day.
Long ago, castles were traditionally part city and part defensive fortress. The moat was a key part of this defense; by surrounding the castle with water, the fortress was more difficult to penetrate. The wider the moat, the more difficult it would be to attack a castle.
A profitable company is like a medieval castle and will undoubtedly attract competitors. Without a strong defense, competitors will be able to copy the offerings of the entity and erode the profits. Thus, the most successful firms are those that boast some sort of sustainable competitive advantage. How can the company maintain its success despite the inevitable attacks by competitors? Companies with wide economic moats operate business models that are difficult — or in some cases even impossible — for competitors to rival.
The Network Edge:
When the value of a company’s service increases for both new and existing users as more people use the service, that is when the company is able jump on its networks. This is a potentially quite potent source of competitive advantage.
Why is everyone using Facebook? Why is a Visa card payment the only way you can think of when you run out of cash? Because that’s where everyone else is. And the value of these companies grows as more people join. As more customers join the network, it makes that network more valuable for other customers.
Low Cost Producers:
Firms that can figure out ways to provide a good or service at a relatively low cost have an advantage because they can undercut their rivals on price. This means that they reap a higher profit margin, or can charge slightly lower prices and maybe try and gain some share from competitors. Coal Mining can be a costly affair. But we have Coal India. Information technology has R & D costs as well. But we have Infosys.
Intangible assets generally refer to the intellectual property that firms use to prevent other companies from duplicating a good or service. Patents are the most common economic moat in this category since it gives a company a legalized monopoly. In certain situations, especially in the pharmaceutical industry, if you have a best-in-class drug,that gives you enormous pricing power. When patents expire, generic competition can quickly push the prices of drugs down by a huge margin.
Copyrights, regulatory licenses, and governmental approvals also fall in this category. How do you think Coke and Pepsi are able to finance and rope in personalities for their extravagant advertising wars? Moats are the key.
A resolute determination to invest in only wonderful companies even if they have to be bought at fair prices is the essence of an Economic moat. An economic moat represents some sort of protection of business cash flows. In other words, businesses with economic moats have sustainability.
“Economic moats for the lack of a better word are good. Moats are right. Moats work. And it is moats that will save the malfunctioning corporation called financial markets.”
Views presented in the article are those of the author and not of ED.