Higher startup costs can also deter future participants in the sector. Moat, a depression surrounding a castle, city wall, or other fortification, usually but not always filled with water. The existence of a moat was a natural result of early methods of fortification by earthworks, for the ditch produced by the removal of earth to form a rampart made a valuable part of the defense system. With the development of firearms, the moat lost much of its importance but was occasionally retained into the 18th century as an obstacle against infantry attacks.
What is a moat example?
In short, moats protect the market share and positioning of companies and facilitate the long-term sustainability of their business model, including the continued generation of profitability. For instance, brand identity and reputation encourage customer loyalty, as seen in the case of Coca-Cola.
Build a narrow economic moat:
This ability to retain customers on an incumbent basis is a powerful moat effect. Companies with economic moats more often than not have higher profit margins, which are a byproduct of favorable unit economics and a well-managed cost structure. Economic barriers to entry often include things like tax laws and regulatory hurdles. High corporate or business taxes and red tape can make it challenging for new players to (want to) enter the market. This can provide existing businesses with a form of protection from new competition.
- The final KPI that we’ll discuss is the free cash flow (FCFs) of a company, which is directly tied to the company’s capacity to spend on growth and re-invest into its operations.
- While certain stocks may appear expensive based on their share price, it is crucial to assess their total market value.
- Put simply, it’s a competitive advantage that prevents other players from stealing market share, sales, and consumers from a company.
- Another type of economic moat can be created through a firm’s intangible assets, which include items such as patents, brand recognition, government licenses, and others.
- After a record-breaking 2021 (1035 IPOs, beating the 2020 record of 480), 2022 saw a massive decline (181 IPOs), and 2023 has been a continuation of that trend.
- They help leverage quickly the significant reach and growth internet products can have.
Companies can increase their cash flow and can guarantee returns for their investors by narrowing out other players by creating a competitive advantage. These returns can be multiplied if businesses can maintain and expand a durable economic moat. Instead of chasing short-term trends, economic moat-based investing encourages a focus on the quality of companies.
Branding
But what if this advantage, which was then so unique to you, could be copied by your competitors, as they see your profits rise? An economic moat is a metaphor that refers to businesses being able to maintain a competitive advantage over their competitors in order to preserve market share and profits. Any method that a company uses to maintain a competitive edge can be considered an economic moat. While advantageous, there may also be some drawbacks that come with economic moats. It often costs companies a lot of money to position themselves as a key player in the market.
Their competitive advantages seek to create a barrier against market fluctuations, mitigating the overall risk in the fund’s portfolio. When a company is able to establish itself in an industry, suppliers and customers can be subject to high switching costs should they choose to do business with a new competitor. Competitors have a very difficult time taking market share away from the industry leader because of these cumbersome switching costs.
Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.
Understanding Economic Moats
What is Apple’s moat?
Apple's competitive business moat is a result of its strong brand, ecosystem lock-in, product differentiation, supply chain expertise, developer ecosystem, intellectual property, retail presence, and financial resources.
Everyone in the venture world has been waiting for months for the re-opening of the IPO window. After a record-breaking 2021 (1035 IPOs, beating the 2020 record of 480), 2022 saw a massive decline (181 IPOs), and 2023 has been a continuation of that trend. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. Just because a company has high margins does not signify a moat, because there must also be an identifiable, unique advantage. Another could be to identify several niches that together would make sense, but from afar might not seem as easily put together.
Brand Moat
Another disadvantage may occur when consumers begin to expect a lot from the dominant industry players. This is especially true when consumers want fair pricing, a certain quality of goods and services, and quick delivery times. The obvious benefit of having a wide economic moat is that the company can keep its rivals at bay.
- A good example of a competitive advantage would be a low-cost advantage, such as cheap access to raw materials.
- Twitch has eaten away a chunk of YouTube’s prominence in some areas, but the deeper search functions on YouTube make it a better broad entertainment platform.
- A moat is a term borrowed from medieval castles that had a wide ditch filled with water around them to protect them from invaders.
- High corporate or business taxes and red tape can make it challenging for new players to (want to) enter the market.
- Technology has disrupted how companies do business, making it more difficult to sustain a competitive advantage over time.
- An economic moat is a metaphor that refers to businesses being able to maintain a competitive advantage over their competitors in order to preserve market share and profits.
- In other words, there must be a unique value proposition and/or a strong reason behind the durability of the future profits (e.g. cost advantages, patents, proprietary technology, network effects, branding).
Economic Moat
“Each step in Apple’s course of conduct built and reinforced the moat around its smartphone monopoly,” prosecutors wrote in Thursday’s lawsuit. The notion that America was secured by two unbreachable moats, the Atlantic and the Pacific, was already about to be invalidated. Our editors will review what you’ve submitted and determine whether to revise the article. Moats were developed independently by North American indigenous people of the Mississippian culture as the outer defence of some fortified villages. The remains of a 16th-century moat are still visible at the Parkin Archeological State Park in eastern Arkansas.
Being able to simply invest and spend your way to scale, product innovation, patents and other competitive advantages is, itself, a kind of moat. Twitter, for example, has been making a loss in virtually every year of its existence, but thanks to some enormously successful capital raising, it has been able to invest its way to a massive and stable audience. It also now has a product suite that other social networks could only dream of, and is now starting to convert this massive pool into revenue. In the context of moats, it is essential to consider the sustainability of a company’s competitive advantage. Take the example of Zomato, which is attempting to build an ecosystem in the food delivery industry.
With no moat, you struggle to get more riders and restaurants to sign up, and the business fails to scale. When one of your rivals offers you a mild amount to acquire your assets and mailing list, you gratefully exit. Six months later one of the big incumbents have what is a moat noticed it, replicated the product, and now your customers are using that instead because it’s cheaper and benefits from the support of the rest of the bigger business. To turn that question around, consider what would happen if your startup didn’t have a moat at all. Say you had a great invention and, in the rush to get it to market, didn’t bother to patent the things about it that made it unique.
What is a moat in slang?
A moat is used to signify a company's competitive advantage which is used to keep them ahead of the competition.
