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Content Journal Voice

Value Investment and Mindset

5 Types of Economic MOAT for Business

In the previous topic of “How to pick good stocks as a value investor?” We discussed analyzing the economic MOAT. Let’s now discuss in detail about 5 types of economic Moat for Business.

Cost Advantage
Size Advantage
Switching Cost
Intangible Assets
Network Effect

🔶Cost Advantage:

It means that the company has lower business costs (for their services and products) compared to other competitors.

A business can definitely lower their selling price and therefore outperform the other competitors. The cost can be in terms of transportation costs, cost of technology, raw material, & procurement costs.

Example:

There are two tech companies with the same service and product with same features and pricing.

Company A:

Invest 40% more that company B in R&D
Product is build with low cost material
Earn more with more profit margin (Sells at 20$ with 5$ costing)

Company B:

Invest less in R&D
Product is build with high cost raw material
Earns less with less profit margin (Sells at 20$ with 10$ costing)

Major example: Amazon (Cost advantage) because it has constantly adopted various artificial intelligence which helps the company with automation, reducing the costs.

🔶Size Advantage:

A company that has the size advantage usually is the company that is big enough to dominate the core market share of a particular industry.

At a certain size a company achieves economies of scale. This means the company is able to produce a large scale of goods and services with lower input costs.

Companies with size advantage normally dominate the core market share or particular industry as a result smaller players will be struggling to compete with this type of company due to available market share are very less.

Example: Imagine market share of company/industry as a big cake

Company A has 80% area in the same industry and Company B has 20% so, company A has size advantage in the same industry.

Banks are a great example of size advantage.

🔶Switching Cost:

When a company is able to establish itself in an industry, suppliers and customers can be subjected to high switching costs. Should they choose to do Business with new competitors?

High switching cost company has the ability to increase the retention rate of its customers hence leads to a more sustainable business.

Example: Company XYZ [Oil and Gas company] {Trying to change vendor}

Vendor A (Current Vendor)

Worked for several years
$100K contract last 5 Years

Vendor B (New to switch)

Offered same service
$80K contract for next 5 Years

Vendor B is a better choice but switching cost is involved if the company wants to switch from vendor A to B.

Example: If any company using Adobe Inc. Softwares (one company standalone) as their work platform and switching from their platform has a higher switching cost.

🔶Intangible Assets:

Simple but strong MOAT and is one of the most important MOAT in evaluating companies nowadays.

It includes intellectual property such as patents, brands recognition, government licenses and others which allows companies to charge more on their product or services.

Example: Apple Inc.

🔶Network effect.:

One of the most potent competitive advantages that occurs when the value of a particular goods or services increases, when more people use it.

Network effect occurs when the value of a particular goods or services increases when more people use it. A company has products or services that everyone is using. It can quickly catapult companies to lead in new industries.

Example: Adobe Inc.

Conclusion: “Skills comes from consistent and deliberate practice”

#economicmoat #moat #business #investment #profit #venture #economy #company

Last Updated: Aug 24, 2024