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Ancient history has a lot to teach us around fighting competition and protecting one’s territory, especially during war. It was strategists who in ancient history that came up with a concept of a moat, that would protect the kingdom’s castle from an attack from its opponents.

Competitive strategy for corporates has been a well-researched topic and Michael Porter has written enough and more about the existence of companies and their competitive advantages around the scale. It’s important to think about what types of advantages a CEO of a company would want to protect themselves from the competition. In this article, I look at answering this question from an investor’s lens, as to what I believe are competitive sustainable advantages that help companies build long-term shareholder value.

One thing that isn’t a source of a moat is technology because that can be duplicated and always will be, eventually, if that’s the only advantage you have. Your best hope in a situation like this is to be acquired or go public and sell all your shares before investors realize you don’t have a sustainable advantage. Technology is one type of advantage that’s short-lived. There are others, such as a good management team or a catchy advertising campaign or a hot fashion trend. These things produce temporary advantages but they change over time or can be duplicated by competitors.

An economic moat is a structural thing. It’s like Southwest Airlines in the 1990s. It was so deeply ingrained in the company culture, in every employee, that no one could copy it, even though everyone kind of knew how Southwest was doing it. If your competitors know your secret and yet still can’t copy it, that’s a structural advantage. That’s a moat.

The way I see it, there are really only four sources of economic moats that are hard to duplicate, and thus, long-lasting. One source would be economies of scale and scope. Wal-Mart is an example of this, as is Unilever in the consumer business or Maruti in the passenger vehicle business. Another source is the network effect, ala eBay or Mastercard or Visa or American Express. A third would be intellectual property rights, such as patents, trademarks, regulatory approvals, or customer goodwill. Disney, Nike, would be good examples here. A fourth and final type of moat would be high customer switching costs. Microsoft, Apple, Facebook are great examples of companies that benefit from high customer switching costs. These are the only four types of competitive advantages that are durable because they are very difficult for competitors to duplicate.

It takes time for a company to build a sustainable moat, in many cases, in excess of 10-15 years and what this means for investors, is if they have to build companies in their portfolios which have sustainable wealth creation potential, it requires portfolio construction which should not exceed 20 investments. In the next part, I will write about what makes a good investor which gives them a sustainable edge which is hard to replicate.



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