A business’ sustainability over the long term depends on its capacity to maintain an enduring competitive advantage. Warren Buffett once described these advantages as an economic moat that protects the castle’s (business) long term profits and market position. Frameworks such as The Morningstar Economic Moat Rating provide a helpful starting point to think about sources of long term competitive advantage in business.
Common Sources of Competitive Advantage
- Cost advantage: Relatively lower production costs or service expenses can enable higher margins, competitive pricing, cushion during downturns, etc.;
- Efficient scale: Conditions that present economies of scale and natural monopolies to the company;
- Network effects: Where the value of or demand for services and products increases when more consumers use it;
- Switching cost: When switching from a product or service to an alternative is costly or troublesome to consumers;
- Barrier to entry: When it is difficult for competitors to enter the industry due to capital requirements, government regulation or other factors;
- Intangible assets: When the company possesses brands, patents, licenses and other intangible assets that protects the company from replication.
References
- Morningstar (2010). Equity Research Methodology. Accessed at <https://www.morningstar.com.au/Stocks/Methodology>
- Morningstar (2012). The Morningstar Economic Moat Rating. Accessed at <https://www.vaneck.com/the-morningstar-economic-moat-rating-pdf/>
- Nasdaq (2015). Six Traits of a Wide-Moat Stock. Accessed at <https://www.nasdaq.com/article/6-traits-of-a-wide-moat-stock-cm458157>