Warren Buffet, an American investor and businessman, was the one who coined the term "economic moat". How do we define economic moat, you ask?
A company with an economic moat is one that has a significant competitive advantage over its competitors. This helps them to stay profitable and protect their market share. This competitive edge could include a patent or a brand name.
The pharmaceutical companies are a great example of a company with an economic advantage, as they often hold multiple licenses for widely-used medicines.
Let's now answer the question "What is an economic moat?". We'll look at how following or evaluating a company's economic moat could benefit investors.
It is important to identify and understand companies with an economic moat. These companies, just like blue-chip businesses, are reliable performers on the stock exchange. Investing in companies that have large economic moats can help you to increase your investment portfolio.
A company must understand how to create an economic moat to ensure that it remains relevant and profitable. You must be able offer a better product or service than any existing or potential competitors or you risk losing market share.
Certain qualities or resources can help a company build an economic moat. One company may have all of these characteristics. A company's competitive edge is stronger if it has a larger economic moat.
These are some of the characteristics or sources that can help build an economic moat around a company's business:
1. Price advantage
You can think of Jio or Wal-Mart as an example. Their greatest advantage is their ability to sell their products and services at a reasonable price. They are able to offer prices that are lower than the closest competitor. These companies are able to offer a price that is unbeatable, even if another company enters the market. Due to multiple issues, other companies that offer similar products cannot afford to charge a lower price than the Wal-Marts around the world.
2. Network effect
Flipkart and eBay are two examples of e-commerce shopping websites. The quality and quantity of users will determine the value of the services offered- selling and buying - and their worth. There will be more buyers if there is more sellers. Buyers will find more of what they need if there is more sellers. It is a matter of "the more the merrier".
3. Switching charges
Let's suppose you need to change your home wi-fi provider because of poor connectivity. You realize that switching to an internet provider will require you to pay a substantial installation and service fee. You will need to pay a significant switching fee if you want to change companies. High switching costs are common in IT and telecommunications companies, which can lead to higher customer retention.
4. Intangible assets
As we have already mentioned, patents, licenses or rights to intellectual properties are intangible assets that a company owns. This ensures that there is no competition or that the closest competitor cannot offer a comparable product or service. One example of this is a pharmaceutical company that manufactures drugs for the treatment of cancer. The majority of pharmaceutical companies retain the patent and are the only manufacturers of the medicine they need. As they have licenses, there is no competition.
5. Efficient scale
Let's suppose that a certain area is rich in coal and that a few companies have already established capital-intensive operations to mine the coal. It would be almost impossible to start a business in this niche market without existing players and the high cost of setting up a footing.
Call your broker immediately if Warren Buffet's story and belief in an economic moat inspire you.