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