Economic Moats

From "The Little Book that builds Wealth" by Pat Dorsey of Morningstar.

He gives a list of common economic moats. This is simpler and more stringent than using Porter's 5 forces. His approach is to go beyond the numbers and find the reasons for high margins.


Brands. Not as important as we think:

• May offer a sustainable competitive advantage if the brand makes people pay more for the same product (e.g.: Tiffanys vs Blue Nile).
• Most brands are for differentiated products, (e.g.: Coke, Mercedes-Benz), these two examples do not cost more than their competitors. A brand's popularity is no indication of an economic moat.
  
• Brands can be lost e.g.: Kraft used to dominate shredded cheese market, but was replaced by supermarket generic brands.
• Can't think of any in Singapore.
  

Patents

• Patents. "Beware of firms which rely on a small number of patents. The only time patents constitute a truly sustainable competitive advantage is when a firm has a demonstrated track record of innovation that you're confident can continue." e.g.: 3M
• Again, none in Singapore.

Regulation

• Prefer industries with strong regulatory barriers to entry, but where the government does not want to control prices. In SG, perhaps Vicom?
  

Switching Costs

• When it costs the customer a lot (in money, time, inconvenience or risk) to switch products. eg: changing bank accounts. Good example is providers of large scale IT projects to government/defense/banks. Maintainence can only be obtained same provider for the projects lifetime, usually 10 years. e.g.: Silverlake Axis
  

Network Effect

• People need to use the product because others use it. e.g.: Facebook, MS-Word, E-bay, Visa. Google does not have this, for example.
  
• Or the company has a strong branch network e.g.: Western Union (money transfer).
  
• In Singapore, Goodpack perhaps. SGX may be a negative example (compared to HK).
  

Cost Advantages

• Better processes. e.g.: Dell, AirAsia. This is a temporary moat, until the competitors are able to copy (usually takes a long time). Not sustainable.
• Location. Mostly for heave and cheap commodity products e.g.: cement, landfill
  
• Ownership of resources. e.g.: own cheapest mineral deposits.

Scale

• Large distribution networks. Extremely hard to replicate. e.g.: McDonald's, Coke, Fedex. On SGX, Petra?
• Economies-0f-scale (large fixed costs). Can't think of any in SG. Mabye Keppel?
• Dominating a niche market. e.g.: Some HDD component suppliers in Singapore.
  

Eroding Moats

• Avoid tech, products/markets change too fast (e.g.: Dell, Nokia). Also avoid anything affected by technology changes e.g.: newspapers, communications (post/phones), book-retailers, cameras). Hmm....these days, the internet changes everything...doesn't leave us with much to look at.
• Change in market landscape....the strength of customers/suppliers. eg: Walmart erodes the brand advantage of many consumer goods.
• Entry of Irrational competitor e.g.: a competitor facing bankruptcy or supported by govt.
• Falling margins is a sign of an eroding moat, may be hard to determine the cause.
  

A final note. Identifying economic moats, and determining if they are sustainable or being eroded, requires a lot of research on the industry. Probably years. Probably beyond a part-time retail investor.