The medieval moat concept still applies in today's world to identify businesses with significant competitive advantages. In the Middle Ages, some castles and forts had ditches dug around them and filled with water. A moat would provide a competitive advantage by making it much harder for intruders. By analogy, a company that has a competitive advantage and is expected to survive over the long term has a moat around its castle. To understand this concept, imagine starting a fruit juice business. We have found that sourcing large quantities of fruit inventory can be cost advantageous. However, this is not a moat. When you discover a technology that extracts more juice from fruit or allows for a better level of product customization that is difficult for competitors to imitate, it becomes a moat.
If you are investing through a fund, you may not be able to analyze the stocks in your portfolio or discuss the moat of the portfolio's constituents with the fund manager, unless the portfolio is built on another rationale (such as momentum). can. The term economic moat was popularized by Warren Buffett. He has a knack for picking inherently good companies that can remain competitive. How can a company set up an outer moat?
Cost-effectiveness: Manufacturing plants located near sources of raw materials, such as coal mines or limestone mines, have cost advantages. When a mine is owned or exclusively leased, it is difficult for competitors to establish plants with similar cost advantages.
Size advantage: Because a company is large, it can attract customers and become a moat in itself. On commodity exchanges, Multi-Commodity Exchanges (MCX) account for the lion's share of trading, which means higher liquidity and lower tick sizes. There are other commodity exchanges, but MCX is big because it's big. There are NSE and BSE, but regional exchanges have declined. In the telecommunications business, license fees and infrastructure costs for installing towers are required. That's very difficult for new entrants.
brand: FMCG and durable goods have certain brands that symbolize authenticity and attract customers. There's nothing to stop a new business from being set up, but it takes a long time to build the appeal it deserves. The tide can only turn if new businesses come up with disruptive innovations and segment leaders fail to innovate. An example of this is Apple. While competition exists in all of Apple's product segments, Apple focuses on price premiums and customer acquisition.
Migration price/migration cost: Some businesses make it easy for customers to switch. Service providers must have an edge to retain their customers. In certain businesses, the nature of the service can make it stick and customers cannot easily switch. People have multiple bank accounts, but usually have a main bank account. Major bank accounts have various links such as salary, EMI, SIP, demat account, bill payment, etc. Customers won't switch off just because of one lack of service.
Community benefits: In online shopping, food delivery apps, ride-hailing apps, etc., there are only a few dominant apps that have higher recall values than others. As more people use our services, more service partners connect with our leaders. It may sound like stating the obvious, but more people use it, so more people use it.
Unique ideas: If you have a patent or similar exclusivity, it gives your business a moat. There are many soft drink manufacturers and brands, but Pepsi and Coke hold a unique position. Although these are sugar concoctions, there is a customer base. In the pharmaceutical industry, patents that confer some degree of exclusivity over long periods of time can be an example of a moat.
Conclusion: Moat is one of the parameters for identifying stocks and funds. This is a bottom-up rather than top-down approach. Revenue and profit leaders in an industry or segment can give you hints about which entities have moats. If the valuation is reasonable, I would choose a company with a moat. Charlie Munger said, “A good business at a fair price is better than a fair business at a good price.” However, prices should be fair and not exorbitant.
Joydeep Sen is a corporate trainer (financial markets) and author.
