And we want to throw crocodiles and sharks and everything else, gators, I guess, into the moat to keep away competitors.”. An economic moat acts as a barrier-to-entry for competing firms aspiring to capture market share, and it protects the long-term viability of a company. The search for high-quality starts with wide-moat stocks. Since the company positions itself as a low-cost retailer, it wants to ensure it gives the lowest prices to its customers. Economic Moat is a proprietary Morningstar data point. Developing a moat isn’t formulaic. Or you can build one that gets deeper and wider as you innovate. Common economic moats include patents , brand identity, technology, buying power and operational efficiency. Leaving Gmail would cost you your list of contacts or historical messages. These companies have competitive advantages, but they are eroding due to a shifting industry landscape. A Competitive Advantage is Different from an Economic Moat There is a great distinction between the typical competitive advantage and a wide economic moat. Hi, I'm Peep Laja—founder of CXL. The concept of Economic moat was popularized by Warren Buffett, the concept refers to a business’ ability to gain a competitive advantage over its competitors, in order to protect its market share and long term profits from competing firms. Charlie Munger calls “network effect” the demand-side economies of scale, as it results when a product or service becomes more valuable as more people use it. The more types of moats a company can build, the better. Zuckerberg felt that any platform with a half-billion users had potential, even if that required a $19 billion bet. Economic Moats. Wal-Mart, for example, has built an economic moat based on its low pricing. Probably the best book I've ever read on the subject is Pat Dorsey's The Little Book That Builds Wealth. Wide moat companies are also protected from inflation since their “monopolistic position” enables them to raise prices at will. Economic Moat: Cost Advantage. Here are seven types of economic moats to look for in a potential business: Brand – a product or service you're willing to pay more for because you know and trust it. Some “intangible” assets are more defined than others. The same applies to quarries. The regional dominance of a single hospital system deters upstarts. The selection on eBay—of products (for buyers) or potential purchasers (for sellers)—took years to build. Instead, he argues, the company has built a digital moat: The reason that we don’t start a company to compete with Zappos is not [its supply chain]. However, the threat of material value destruction is low, and normalized returns exceed costs of capital in most cases, leaving us comfortable assigning narrow moats to … And why is it so difficult for others to compete? You needn’t decide on a company with multiple moats to think about that it is a potential investment candidate. After researching hundreds of companies, we've identified four main types of economic moats. Many shopping malls have a strong economic moat because they "control" the geographic region around them. Mid-season trades are competitive advantages. Those integrations can be lucrative, like Salesforce’s integration with Google Analytics 360. Learn how to invest like a pro with Morningstar’s Investment Workbooks (John Wiley & Sons, 2004, 2005), available at online bookstores. In other instances, consumers may not know that they benefit from use of their customer data. Technological innovation is a disrupter. The moat around their business is the two million links into their website. Efficient scale. HubSpot’s Brian Halligan contends that Zappos’ moat doesn’t depend on its supply chain—a competitive advantage, perhaps, but a shallow moat at best. If you picture a typical company as a castle that is constantly under attack by its enemies, or competitors, you’ll have a better understanding of just how important an economic moat is in helping a business to thrive and survive in the marketplace. Start up costs. The Network Effect. The economic moat is a benefit that’s built to last and it will ultimately determine whether a company is set up for prolonged success or inevitable failure from an investment point of view. An economic moat is basically anything that gives a business some form of built-in protection for its ongoing generation of cash flow. Morozov: And other source of economic moat, such as cost advantage, switching costs, they all do require, ultimately, our analysts to develop confidence about those sources being very durable. While email contacts transfer to other providers, interoperability isn’t common everywhere. determining the competitive advantage of any given company and, above all, the durability of that advantage. Narrow-moat companies typically come in two varieties: Firms with Eroding Moats. There are five types of moats: 1. A company with a formidable competitive advantage has a "wide" economic moat, while a company with a vulnerable competitive advantage is said to have a "narrow" moat. https://t.co/tAKT5yAd3p. If there is no moat, competition will be increased. (And competing products pale in comparison.). For example, many companies that use the network effect also benefit from economies of scale, because these companies tend to grow so large that they dwarf smaller competitors. Several prominent business-focused investors have spent years identifying and describing the different types of economic moats a company can build to protect its business. And you reap the rewards of greater engagement. Musk believes that moats are largely illusory—and also lazy. “Elon may turn things upside down in some areas,” but, Buffett suggested, “I don’t think he’d want to take us on in candy.”. The rise of social networks and on-demand business models brought the term into more prominence, but they have been always been around, think: hobby clubs, phone switchboards, and old-fashioned town markets. I send a weekly newsletter with what's on my mind on this stuff. In this article, we're going to discuss what an economic moat is, why it is important for business-focused investors, and give an overview of some different types of moats. Firms that offer a product that is integral to their customers’ operations and where the product is complex, making retraining a major cost and inconvenience, have a powerful economic moat. An effective moat doesn’t require Amazon’s distribution network or Microsoft’s monopolistic software strategy. The longer you will benefit from its profits. It is, Rumelt explains, the management of Walmart stores as a network. The primary goal is user acquisition. Doing so, in turn, has earned the company favorable publicity—publicity that digs an adjacent moat built on brand. Consumers will pay more for a bag of Frito-Lay chips than for a bag of generic chips. After training to learn to use a specific product, switching to another would require the surgeon to forgo comfort and familiarity--and what patient, much less surgeon, would want that? Undercutting competitors while making a profit doing so is the crux of a company with such a moat. Nike is the world’s largest athletic footwear, apparel, and equipment player with a focus on performance sporting goods. Musk wasn’t impressed: Then I’m going to build a moat & fill it w candy. Anything that helps the firm in protecting its profitability its peers is a moat. A Wide Moat. Warren Buffett said that, "A good business is like a strong castle". Types of Economic Moats Broadly speaking, Economic moats can be classified into four categories: Intangible Assets. Patents and trademarks are legal lines. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors. These include intellectual property, such as patents, trademarks, copyrights, and proprietary technology; brand names; and goodwill, such as a positive reputation, strong employer-employee relations, and customer base. Software adoption—a moat of network effect—can protect a business from newcomers. “I think moats are lame,” Musk responded. Low-cost production; 2. Licences or Patents . Testing for an Economic Moat. A company with a license to serve electricity, gas to its customers in a geographic region is a MOAT. Types Of Economic Moats The development of a competitive advantage is the basis for a company's ability to … In terms of value investing, moat is basically an entry barrier that provides competitive advantage to a business , which helps in maintaining its market share and thus, profits for a longer run. In Course start thinking like financial analyst, we identified the four main types of Economic Moats, and below we provide a bit more detail, using examples. So it doesn’t allow companies to provide premium services. It’s why Musk believes moats are irrelevant. The number of race fans or events won’t double with the availability of second track. But a dominant position incentivizes practitioner learning, which, in turn, reinforces the software’s position in the market. Technological change, however, has created opportunities for new kinds of moats. Low-Cost Producer. Baseball offers an analogy. If you can make it for less, you can sell it for less. Intangible assets. This field is for validation purposes and should be left unchanged. 1) Brand Moat. I do a lot of thinking, reading, and writing around business, strategy, and optimization. Detractors, like Musk, ask pointed questions about the long-term costs of moat-building. Cost. In the United States, the consolidation of health-care systems is a model for efficient scale moats: a rash of regional acquisitions. Compared to patents, brand is fragile. So are regulations, which, in some instances, are a cynical moat-digging campaign. When geography is the determining factor, efficient scale relies on mergers and acquisitions. Sure, you can give it a shot. I'm a former champion of optimization and experimentation turned business builder. Morningstar initiated economic moat rating in late 2002, subdividing entire coverage universe into three moat buckets: none, narrow, wide. What is the guiding principle: fear or ambition? WhatsApp focused on driving user adoption, and Facebook bought the company in 2014 without knowing how to monetize users. The feud started when Musk was asked about Tesla’s decision to make its network of fast chargers accessible to other automakers (for a fee). The term economic moat was coined and popularized by the Oracle of Omaha himself, Warren Buffett. “It’s nice, sort of quaint, in a vestigial way. II. It can give a team the third starter or extra bat they need to make a playoff run. The. In general, the more types of economic moat a company has--and the wider those moats are--the better. Musk, by making his fast chargers available to others and open-sourcing Tesla’s patents, has intentionally filled a potential moat. Inbound marketing may build a brand. Looking at the company’s historical performance is important if we want to identify whether it has an economic moat or not. No moat, however wide or deep, can protect a company from complacency. For anyone wanting to sell something online via an auction, eBay (EBAY) provides the most potential buyers and is the most attractive. Types of Narrow Moats. Companies aim to create high switching costs in order to "lock in" customers. Join 100,000+ growth marketers, optimizers, analysts, and UX practitioners and get a weekly email that keeps you informed. Uber and eBay have something in common. There are various different by which a company can create an economic moat in the market that will allow it to gain the significant level of advantage over the competitors where some of the ways include cost advantage moat, intangible assets moat, high switching costs moat, size advantage moat, and the soft moat, etc. Given how tough it is to build an economic moat in the industry, investors should back up the truck when wide-moat retailers become cheap. They build profits on the power of brands to distinguish their products. Scale allows Wal-Mart to do its own purchasing more efficiently since it has roughly 5,000 large stores worldwide, and it gives the company tremendous bargaining power with its suppliers. Network effects, arguably the most powerful kind of economic moat, occur when a product becomes more valuable as more users join. But this type of economic moat can be very powerful and long-lasting, so it’s worth taking the time to seek it out. Followers are non-transferable capital that users store on the platform. For those unfamiliar, it will act as an introduction to economic moats. ), “Intangible assets constitute patents and trademarks,” writes Alex Graham, “but also hard-earned competitive advantages, such as brand names and culture.”. Not surprisingly, the most popular products—freemium or not—earn early and powerful integrations. This is why the company is orienting towards discussing privacy and protecting your data. A slow, costly grind eventually hits a tipping point, when exponential growth finally delivers profitability. A moat in cost is a competitive advantage a firm can strive to achieve. You can build a moat that jealously guards an advantage without extending it. Location. It’s an interesting argument in favor of a freemium version of a SaaS product. There are certain intangible assets that act as economic moats. So, how important is it that a company has a well-established economic moat? As the value of a brand increases, the manufacturer is also often able to be more demanding in its distribution relationships. But it also widens the moat in other ways, with hard-won backlinks and engaged social media followings. If your only defense against invading armies is a moat, you will not last long. The increasing competitiveness in organic search and social media has deepened that moat for new entrants. They should encourage, not stifle, innovation. But there is generally too much risk associated with estimating cash flows that are not protected by a moat. A company that can produce a quality good or service and deliver it to the consumer cheaper than its competitors has a cost advantage. They’ve inspired imitators, such as Drift, which coined “conversational marketing” when it knowingly entered a commodity market. It’s one that many venture capital–funded startups deploy. It is a strong barriers against antagonism from others companies or firms. In general, the more types of economic moat a company has--and the wider those moats are--the better. They build a lifestyle around the Harley-Davidson culture. Another type of economic moat can be created through a firm's intangible assets, which includes items such as patents, brand recognition, government licenses and others. How are we going to do that? Economic moats remain tethered to investing: A bigger moat makes a stock a better bet. But companies with moats share common characteristics. Examples of well-known brands that do not have an economic moat: MakeMyTrip, Flipkart, Videocon, etc. But demand won’t scale. The moat offered nothing to consumers but made it easy for cell phone companies to keep clients around. Supply. Does this effort build a sustainable, meaningful competitive advantage? (You could export them, but there’s still a cost.). That is the fundamental determinant of competitiveness.”, When told of Musk’s comment’s, Buffett acknowledged that technological change has made moats more vulnerable but not irrelevant. If your customer data allows you to deliver more relevant content, the customer has a better experience. Meanwhile, for buyers, eBay has the widest selection. Bigger isn’t necessarily better when it involves digging an economic moat.. Examples of businesses with intangibles include Pfizer, a pharmaceutical company with a roster of patented drugs; Nikewith its (generally) positive reputation for quality and relevance; and Chipotle with its commitment to “naturally r… . Allows firms to sell at same price as competition and gather excess profit and/or have the option to undercut competition. An economic moat represents some sort of protection of business cash flows. The key words here are non-replicable, sustainable and structural. Leaving—or splitting time to pursue fans on a new network—comes at a cost. Sure, you can give it a shot. The data required comes…. It’s not the deepest moat. Their products become more valuable as they acquire users. Economic moats are incredibly important simply because it is impossible to estimate future cash flows without an economic moat. Examples of businesses with intangibles include Pfizer, a pharmaceutical company with a roster of patented drugs; Nikewith its (generally) positive reputation for quality and relevance; and Chipotle with its commitment to “naturally r… Constine isn’t the only one with that opinion: Facebook *wants* privacy regulations to entrench its monopoly power. If a company's success is based on something that others can't replicate, it is much more likely to retain its top spot. The answer isn’t merely the reduced costs that come with scale, like buying in bulk. exclusive integrations with Google Analytics 360, depend on limited demand and geographic dominance, our current marketing operations role included, How to Analyze Your A/B Test Results with Google Analytics, 5 Analytics Questions You Should Always Ask, Why You Shouldn't Trust the Conversion Rate in Google Analytics, Website Information Architecture: How to Optimize for UX. 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