An economic moat is a strategic advantage that a company has over its competitors. It is often attributed to investor Warren Buffett. The economic moat is similar to a castle’s moat, in that certain advantages protect a company from its competitors. In this article, we will cover Intangible assets, Efficiency of scale, Patents, and Switching costs. These are all valuable advantages to consider when building an economic moat.
Intangible assets
Companies can benefit from a strong economic moat by utilizing intangible assets to protect their business. These assets include brand names, patents, and government licenses. While these assets are difficult to quantify, they provide an excellent way to protect a company’s competitive edge. For example, patents protect inventions from unauthorized commercial use, while government licenses put entry barriers in the way of new competitors. Similarly, brand names can generate a high level of customer loyalty, promoting sales and fostering trust.
Cost-based competitive advantages allow companies to undercut their rivals and capture market share. For example, large retail establishments can deliver products for lower prices to consumers, but companies with a high economic moat can increase their prices when necessary. Furthermore, businesses with unique trademarks and patents can slow rival firms down by limiting the use of their products. Biotech companies rely on patents in medical technology and software, and media companies copyright works of art and intellectual property to protect their exclusive content. By protecting these assets, companies can develop a strong economic moat based on product differentiation.
Economic Moats Switching costs
The ability to sustain and defend long-term profitability is called an economic moat. Morningstar lists five sources of moat: intangible assets, switching costs, network effect, and cost advantage. An economic moat develops when a company provides a product or service that users need, but cannot afford to switch to a competitor. Such pricing power gives the incumbent supplier a price advantage and economic profits. Here’s how switching costs work.
The ability to consistently outperform competitors is a common example of an economic moat. Companies with industry-standard products can invest in further growth opportunities. Examples include Adobe and Microsoft, which have their respective creative suites and office suites, and Apple, which offers operating systems. However, it’s not always so easy to distinguish among industry leaders. Fortunately, there are companies that have a long-standing competitive moat, such as Altium.
Efficiency of scale
An economic moat is a business’s ability to maintain a competitive advantage and defend long-term profitability. Morningstar defines five major types of economic moat: switching costs, intangible assets, network effect, and efficient scale. In this article, we explore efficient scale and how it affects a company’s moat. Basically, an efficient scale environment is one in which there are few competitors and fewer competitors can exploit its advantage.
In other words, an economy of scale is a firm’s ability to lower its costs. While any company can technically price products very low, the only companies that can offer those prices are those with rock-bottom operating costs. This is because economies of scale are often tied to low prices. Amazon’s low prices are the result of economies of scale. However, the company would not have a moat if it were charging for its services.
Economic Moats Patents
A company with a strong patent portfolio enjoys a competitive advantage. A strong patent portfolio provides M&A leverage, keeps competitors at bay, and offsets R&D expenses. In addition, patent monetization can offset R&D costs. However, an economic moat may not be easy to define or quantify. Here’s an example. In the late 1990s, Palm introduced PDAs that took the market by storm. By 2001, these devices had become commodities. Other companies, including Hewlett-Packard and Research in Motion, began integrating PDA-like elements into their handsets.
Companies can also create an economic moat by owning a highly-recognizable brand. Brand name recognition is a powerful advantage. Patents grant a company exclusive rights to processes and formulas. Pharmaceutical companies use patents to gain a moat because their competitors would have to spend money to produce similar drugs. Moreover, they would have to invest significant time and resources in research and development of new drugs. A strong economic moat allows a company to charge higher prices and maintain a higher market share.
Market share
An economic moat is a distinct advantage over the competition that can limit the movement of consumers. Intangible assets such as brand recognition, goodwill, and technology are examples of economic moats. Moreover, a company with a broad economic moat can charge a premium for its products, making switching a difficult proposition for competitors. However, it is not just tangible assets that create economic moats; intangible assets are also important.
One of the most common ways to create an economic moat is to become large. This way, companies can achieve sustainable long-term value creation. Companies with large economic moats tend to dominate their core market share. Smaller companies are forced to compete with large companies or occupy niche roles. A small company can use a low-cost product, but can’t compete with a large, established company. For example, the cost of production of a computer product can be much lower than its competitors’.
