Understanding Moat Analysis: Unlocking a Companys Competitive Advantage by Yunus Emre AKSU

It was estimated that earliest construction began in 800 and continued into the mid-15th century. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. The more efficient a company can convert its operating cash flows into free cash flow (FCF) – i.e. FCF conversion and FCF yield – the more cash flows are available to use to obtain a higher return on invested capital (ROIC).

High Switching Costs

This time, your competitors will have no way of duplicating your methods, as your competitive advantage is protected by your patent. In this example, your economic moat is the patent that you hold on your proprietary technology. In this case, if your lemonade company was a public firm, your common stock would probably outperform that of your competition in the long run. Switching costs are another type of economic moat, which makes it very time-consuming and expensive for consumers to switch products or brands. Autodesk Inc. offers various software solutions for engineers and designers that are very difficult to learn.

Size Advantage

So dominating the competition and keep improving the operating profit margins along with bottom line is a clear sign the company is developing a moat. If the cost of production is ₹10 and if it can sell it for ₹50, it has a very high-profit margin. The reason the company can’t sell the product at ₹50 is that competitors sell them at ₹20. Economic moats are generally difficult to pinpoint at the time they are being created.

1. As a basic method of pest control in bonsai, a moat may be used to restrict access of crawling insects to the bonsai.
2. Social media platforms, collaboration tools, and online marketplaces are prime examples.
3. In this case, the most important factor is the longevity of the moat.
4. Similarly, Page Industries is so well optimized in the production of inner wears.

Once an Autodesk customer starts using its software, he is unlikely to switch, allowing Autodesk to charge premium prices for its products. Intangible assets refer to the patents, brands, and licenses that allow a company to protect its production process and charge premium prices. Pharmaceutical companies earn high profits due to patented drugs after spending billions on research and development. In other words, there must be a unique value proposition and/or a strong reason behind the durability of the future profits (e.g. cost advantages, patents, proprietary technology, network effects, branding).

Example of an Economic Moat

The existence of a moat was a natural result of early methods of fortification by earthworks, for the ditch produced by the removal of earth to form a rampart made a valuable part of the defense system. With the development of firearms, the moat lost much of its importance but was occasionally retained into the 18th century as an obstacle against infantry attacks. Moats were excavated around castles and other fortifications as part of the defensive system as an obstacle immediately outside the walls. A moat made access to the walls difficult for siege weapons such as siege towers and battering rams, which needed to be brought up against a wall to be effective. A water-filled moat made the practice of mining – digging tunnels under the castles in order to effect a collapse of the defences – very difficult as well.

Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. European colonists in the Americas often built dry ditches surrounding forts built to protect important landmarks, harbours or cities (e.g. Fort Jay on Governors Island in New York Harbor). Moats were developed independently by North American indigenous people of the Mississippian culture as the outer defence of some fortified villages.

This reduces overhead costs in areas such as financing, advertising, production, etc. A wide economic moat can be caused by several factors that might make it difficult for other businesses to steal market share. These factors may include high barriers to industry entry, or the business with the moat might own patents on several products that are essential to providing their particular product or service. Moat refers to the competitive advantage belonging to a particular company that protects its profit margins from competitors in the market and other external threats.

Efficient scale arises when a particular market is best served by a limited number of companies, giving them near-monopoly statuses. Utility firms are examples of companies with an efficient scale that is necessary to serve electricity and water to their customers in a single geographic area. Building a second utility company in the same area would be too costly and inefficient. For instance, Apple (AAPL) is a clear example of a company with an economic moat from various sources, but the one we’ll focus on here is its switching costs. In the absence of an economic moat, a company is at risk of losing market share to its competitors, particularly nowadays as software continues to disrupt all industries.

A distribution moat is formed when a company possesses an extensive distribution network or a specialized supply chain. This can make it challenging for competitors to match the distribution capabilities. Creating a distribution moat involves efficient logistics management and the ability to sustain growth. In today’s fast-paced business world, maintaining a competitive edge has become increasingly challenging. However, some companies seem to thrive in even the most competitive environments.

The outer moat of a Japanese castle typically protects other support buildings in addition to the castle. Hence, the Apple product users tend to be some of the most loyal customers, which directly coincides with more long-term recurring revenue. For Apple, not only is it expensive for customers to switch to a different product offering, but it is difficult to escape the so-called “Apple Ecosystem”. The more difficult it what is a moat is to switch to a rival offering – either due to monetary reasons or convenience – the stronger the moat is around the incumbent, or, in this case, Apple.

Similarly, a company having a license to do a specific type of business can be considered a MOAT as well. Similarly, Page Industries is so well optimized in the production of inner wears. In the dictionary, a moat means a deep and broad dug that surrounds and protects a castle. Some consider excellent management as MOAT, whereas others consider growth and a better business environment as the MOAT for the business. However, suppose you develop and patent a juicing technology that allows you to get 30% more juice out of the average lemon. This would have the same effect of reducing your average cost per glass of lemonade.

A brand moat is created when a company builds a powerful brand presence around its products or services. Consumers tend to gravitate toward familiar and trusted brands, making brand loyalty a significant factor in strengthening this moat. Building a brand moat often requires years of consistent quality and customer satisfaction. For example, Coca-Cola’s global brand strength is a classic example of this type of moat. Apple has a few economic moats, the primary one being creating products that did not exist before, such as the iPod, the iPhone, and the iPad.

After the creation of those products, Apple’s economic moat has consisted of its marketing, its design, and its user-friendly interface. From an investor’s view, it is ideal to invest in growing companies just as they begin to reap the benefits of a wide and sustainable economic moat. In this case, the most important factor is the longevity of the moat.