A closer look at in­vest­ment moats

What con­sti­tutes a strong in­vest­ment moat? We look at ex­am­ples of com­pa­nies that got it right.

Finweek English Edition - - MARKETPLACE INVEST DIY - Ed­i­to­rial@fin­week.co.za

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writ­ten be­fore about in­vest­ment moats, a con­cept cred­ited to War­ren Buf­fett. Es­sen­tially an in­vest­ment moat is some­thing that keeps com­pe­ti­tion at bay so that the com­pany can make prof­its with­out threats to its core busi­ness.

There are two con­sid­er­a­tions you need to take into ac­count where moats are con­cerned. The first is cor­rectly iden­ti­fy­ing the moat, while the sec­ond is ac­cept­ing that no moat is 100% im­preg­nable, es­pe­cially in the tech­nol­ogy age when some­thing com­pletely new can come along and turn a com­pany’s moat into a bar­ren waste­land within a mat­ter of years.

Iden­ti­fy­ing a moat

Telecom­mu­ni­ca­tions in­dus­try First let’s delve into iden­ti­fy­ing a com­pany’s moat. It may be leg­isla­tive such as we see in the tele­coms space. In or­der to set up, a telecom­mu­ni­ca­tions op­er­a­tor needs a li­cence from the In­de­pen­dent Com­mu­ni­ca­tions Au­thor­ity of South Africa (Icasa).

Lo­cally we have four mo­bile op­er­a­tors, who have a leg­isla­tive moat of sorts in that it is un­likely that a new op­er­a­tor will come onto the scene. But the re­al­ity is that as there are four op­er­a­tors, they are in fierce com­pe­ti­tion with one an­other.

Fur­ther, we have seen some breach­ing of the moat with the in­tro­duc­tion on mo­bile num­ber port­ing, mak­ing it easy to switch from one op­er­a­tor to an­other. So the leg­isla­tive moat is more about pre­vent­ing fur­ther com­pe­ti­tion from en­ter­ing the mar­ket and not about stop­ping cur­rent com­pe­ti­tion be­tween ex­ist­ing play­ers.

The SAB ex­am­ple A great ex­am­ple of an in­di­vid­ual com­pany moat was SAB back in the 1980s. The com­pany’s moat was not the qual­ity of the beer it pro­duced; in­stead, SAB’s moat was its dis­tri­bu­tion chan­nels. Think about it: have you ever been to a place that sells beer (bar, ho­tel, restau­rant, bot­tle store, etc.) and not seen SAB prod­ucts avail­able for sale? Its dis­tri­bu­tion net­work was mas­sive and reached ev­ery cor­ner of SA. You could make a bet­ter beer (and many did), but if you couldn’t get your prod­uct out to cus­tomers in an ef­fec­tive man­ner, it didn’t mat­ter.

In South Africa, the com­pany, which has since be­come SABMiller, has man­aged to re­tain its moat. How­ever, its moat is not quite as ef­fec­tive over­seas as the com­pany’s in­ter­na­tional ex­pan­sion sud­denly saw it de­liv­er­ing beers all over the world. SABMiller does not have the level of lock­down on dis­tri­bu­tion in the new mar­kets that it en­joys in SA.

Coca-Cola A moat can also be some­thing as sim­ple as a brand. Think of Coca-Cola, a mas­sive global brand that has more and more com­pe­ti­tion ev­ery year as new and dif­fer­ent soft drinks en­ter the mar­ket. Yet Coca-Cola re­mains one of the top global brands and, bar­ring a dis­as­ter, it will re­main so.

But we do have ex­am­ples of brands tak­ing se­vere knocks – back in the 1980s Per­rier owned the bot­tled wa­ter mar­ket, but in 1990 it was dis­cov­ered that some of its bot­tles had been con­tam­i­nated with ben­zene. Per­rier had to with­draw 160m bot­tles world­wide. While the com­pany is still around, it lost its early mar­ket dom­i­nance.

If your moat is of­fer­ing the cheap­est prod­uct or ser­vice, there’s al­ways a risk that a com­peti­tor will just drop its price.

Other types of moats One area that is not a must is price. If your moat is of­fer­ing the cheap­est prod­uct or ser­vice, there’s al­ways a risk that a com­peti­tor will just drop its price. An ex­cep­tion would be if you had tech­nol­ogy that en­abled you to pro­duce your prod­uct cheaper than the com­pe­ti­tion, but will your com­peti­tor catch up one day? A niche prod­uct is an­other po­ten­tially dan­ger­ous moat. Back in the 1980s, there were two com­pa­nies who owned the global tele­phone an­swer­ing ma­chine mar­ket. But now we all have voice­mail, which is gen­er­ally free, so that niche has dis­ap­peared. At the end of the day the re­al­ity is that few moats live for­ever as trends change, tech­nol­ogy comes into play and pro­cesses adapt. So while it’s great for a com­pany to have a moat, when in­vest­ing, keep in mind that a busi­ness must have other awe­some qual­i­ties so that it can sur­vive and even thrive when its in­vest­ment moat is be­ing breached.

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