Economic Moat Definition
The basic meaning of Economic Moat as explained by Warren Buffet is to draw a competitive advantage over the competitors that are, developing the brand, its products and/or services in such a manner that makes it difficult for the competitors to mimic and hence is a long term advantage for the company to sustain and grow in the market in comparison with the competitors and rivals.
Top 5 Types of the Economic Moat
The different types of ways by which economic moat can be created are as follows:
- Cost Advantage Moat: There is a cost advantage to the company that the competitors are not allowed to make the replica of their product. This is one of the most important economic moats.
- Intangibles Assets Moat: Company can also create an economic moat with the help of intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. like patents, trademark and brand recognition, etc as with the help of this charge a premium can be charged by the company for selling its products in the market when compared with its competitors.
- High Switching Costs Moat: Switching over cost is a disruption cost, the competitors incur by switching their preferences from one company to its customer, which is very high for the customers of a company having an economic moat.
- Size Advantage Moat: When the size of the company is big then the same is its economic moat as the company will be able to achieve the economies of scale where there will be the production of more units with lower the input costs.
- Soft Moats: There are cases when it exists in the company but the same is very difficult to identify and difficult to describe. this type of moat is known as the soft moats.
Example of Economic Moat
Let’s discuss an example of an economic moat.
There is a company ABC Inc. which is in existence for more than 50 years in the market having branches all over the world. It sells some eatables products in the market at a huge profit for which the company developed and registered a patent for its technology. After registering the patent rights, the competitors of the company cannot copy its methods to make duplicate products in the market. Thus it is the competitive advantage of the company which is protected by its patent. This is an example of an economic moat.
Advantages of Economic Moat
There are several different advantages of the economic moat providing the opportunity for the international investors and the issuer of the ADR. Some of the advantages 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 to maintain the desired profitability even in situations of depression. So, in case of depression when many companies are forced to close their businesses, the companies having the economic moat would mostly be able to survive in the market.
- They give a huge contribution to maintain the market share and to make the customers choose its products and/or services over its competitors because the value of goods and services grows among the competitors.
- Switching over cost is a disruption cost, the competitors incur by switching their preferences from one company to its customer, which is very high for the customers of a company having an economic moat. Thus this gives an advantage to the company having the high switching costsSwitching CostsSwitching cost is the cost suffered by a customer when switching a service, product, or supplier. It includes not only financial costs, but also psychological costs, time costs, and so on. moat.
- The company is able to generate a good amount of profit using economic moat since it can charge premium prices for its competitive goods and services.
- One of the reasons for competitive advantage is being cost-effective, i.e. providing the goods and services to customers at a price lower than competitors, hence it is eventually useful in reducing various unnecessary and avoidable costs.
Disadvantages of Economic Moat
The different limitations and drawbacks of the economic moat include the following:
- Where there is a well-established competitive advantage, there is a very high expectation developed by its customers that makes it difficult for the company to continuously fulfill the expectations of all of its customers in the market.
- Where a company develops some unique features or qualities in its products and/or services, there is a constant threat that the competitors would copy, hence it requires a very strong security procedure to make it safe from competitors.
- Developing competitive advantage involves huge costs which makes the products and services quite expensive for the customers to afford.
- The company developing economic moat in technologies usually requires a skimming pricing strategy which makes it difficult for the company to enter the market.
- Where the reason for an economic moat is leaked to competitors, then the competitors may provide it to customers without incurring any development cost as against incurring huge costs and overheads.
- For some industries, an economic moat is not really required since it belongs to the orthodox and rigid customers who are not ready to accept changes.
Some of the important points are as follows:
- There are various different by which a company can create an economic moat in the market that will allow it to gain the significant level of advantage over the competitors where some of the ways include cost advantage moat, intangible assets moat, high switching costs moat, size advantage moat, and the soft moat, etc.
- It is a long term advantage for the company to sustain and grow in the market in comparison with 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 by the different ways such as developing the brand image of its products and/or services in such a manner that makes it difficult for the competitors to duplicate the same. It helps a company to maintain the desired profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance. 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.
This has been a guide to what is economic moat and its definition. Here we discuss the top 5 types of economic moat along with an example, advantages, and disadvantages. You can learn more about fixed income from the following articles –