Economic Moat

Economic moat refers to a company that is capable of enjoying competitive advantage over its rivals, thereby managing to secure its market position without any threat. This criterion makes a firm or a brand difficult to duplicate. As a result, they become one of their kinds.

Economic moat can be narrow or wide, given the sustainability of its competitive advantage. Being competitive advantage means that the company or brand offers similar goods and services as their competing players, but they outperform the rivals’ products in some way, thereby becoming the irreplaceable choice for consumers.

• An economic moat is the ability of a brand or company to gain a competitive edge over rivals by developing a brand, products, and services in a way that makes them challenging for rivals to imitate. In light of competitors and rivals, the company has a long-term advantage in maintaining and expanding.
• The five ways in which one can become an economic moat are cost advantage, intangible assets, high switching costs, size advantage, and soft moats. 
• Companies with such abilities retain the expected profitability even in a depression. During the depression, when many companies forcefully closed their businesses, the companies with the economic moat would mostly survive in the market.

An economic moat, as explained by Warren Buffet, is a firm or brand that draws a competitive advantage over the competitors by developing its products, and/or services in a manner that makes it difficult for the competitors to mimic. Hence, it is a long-term advantage for the company to sustain and grow significantly as compared to its competitors and rivals.

The main motive of the economic moat in the company is to attain a competitive advantage in the market over the competitors in different ways, such as developing the brand image of its products and/or services that makes it difficult for the competitors to duplicate the same. It helps a company maintain the desired profitability even in situations of depression. But with the well-established competitive advantage, there are very high expectations developed by the customers that make it difficult for the company to continuously fulfill the expectations of all of its customers in the market.

The economic moat is classified into two categories – narrow and wide. While a narrow moat signifies the limited competitive advantage of a company over its rivals, a wide economic moat implies sustainable criteria of a brand that enable them to secure its position, profits, and market share for the longer term.

There are different ways in which an entity can create an economic moat to become one of its kind. To understand what is an economic moat, it is important to explore these ways. Some of them are as follows: –

Low-cost production

This cost advantage makes companies outperform the products and services offered by their competitors. The feature makes it difficult for rival companies to replicate the products and sell them at a lenient price.

Intangibles Assets

The company can also create an economic moat with the help of intangible assets like patents, trademarks, brand recognition, etc. Using this, the company can charge a premium for selling its products in the market compared with its competitors.

High Switching Costs

Switching costs are quite high as expecting suppliers and customers to consider other brands when one brand already enjoys a competitive advantage over others is quite difficult. Hence, such costs help build an economic moat.

Size Advantage

When the company’s size is big, it is yet another way of creating its economic moat as the company is likely to achieve economies of scale where there are more units with lower input costs.

Soft Features

These are criteria that exist in the company but are not easy to identify and describe. Hence, such features become soft moats.

Example #1

Let us consider the following economic moat examples to understand the concept better:

There is a company ABC Inc. that has existed for more than 50 years in the market, having branches worldwide. It sells some edible products at a huge profit, for which the company developed and registered a patent for its technology. After recording the patent rights, the company’s competitors cannot copy its methods to make identical products in the market. Thus, it becomes the company’s competitive advantage which the firm can use to protect its products and services against duplication.

Example #2

Players in the hardware industry can be considered to have economic moats, given the products’ contribution to guaranteeing long-lasting profits and protecting significant market share. Though software units face lower barriers to entry than hardware product developers, their survival rate is less after consumers use an app or software product a few times in a row. On the contrary, hardware players might find it difficult to enter the market, but once they prove their worth, they enjoy a competitive advantage over the competitors.

There are several advantages providing the opportunity for international investors and American Depository Receipts (ADR) issuers. Some of the benefits are as follows: -

• Companies with economic moat are more likely to withstand their competitors and maintain market share to remain successful.
• It helps a company maintain the desired profitability even in depression. So, in case of depression, when many companies close their businesses, the companies having the economic moat would mostly be able to survive in the market.
• This help maintains the market share and makes the customers choose their products and/or services because of the increasing value of goods and services in the market.
• An economic moat in the form of patents and copyright helps charge premium prices for its competitive goods and services, thereby enabling companies to reap profit.
• One of the reasons for competitive advantage is cost-effectiveness, i.e., providing goods and services to customers at a lower price than competitors. Hence, it is eventually useful in reducing various unnecessary and avoidable costs.

Besides the advantages, it also has some limitations and drawbacks. These include the following:

• With a well-established competitive advantage, there is a very high expectation of customers, which makes it difficult for the company to handle its customers’ demands and desires.
• When a company develops unique features or qualities in its products and/or services, competitors constantly threaten to copy. Hence, it requires a robust security procedure to protect its items from competitors.
• Developing a competitive advantage involves huge costs, making the products and services quite expensive for customers.
• Creating it in technologies usually requires a skimming pricing strategy, making it difficult to enter the market.
• Some industries do not require moat building since they have orthodox and rigid customers who are not ready to accept changes.

This article has been a Guide to Economic Moat meaning. Here, we explain the ways of creating the moat along with the advantages, disadvantages, and examples. You can learn more about fixed income from the following articles: -

• Equity in Economics
• Grexit Meaning
• Economic Recession
• Economic Risk