Durable competitive advantage is something I like to see in stocks. Also referred to as a moat among investors, durable competitive advantage refers to a business’ ability to maintain its competitiveness over the competition and successfully protect its long-term profits and market share.
The reason this advantage is often called a moat is because it protects the business from external forces, much like a moat protects a medieval castle and those inside it from outside invaders. The wider the moat, the larger and more sustainable the competitive advantage of the firm.
Sustaining business success
One of the biggest threats to a business’ ongoing success is often their competitors. A basic rule of modern economics is that, over time, competition will erode any competitive advantages enjoyed by a business. This often occurs as a result of competitors copying the successful aspects of a business to reap the rewards for themselves, therefore creating more competition and lowering returns for the original company.
Businesses need to be able to hold onto their competitive advantage – that is, what makes them stand out – to ensure business success. This may include allowing the business to earn above-average profits and maintaining a strong cash flow for a sustainable period. These are the stocks to look out for.
What does durable competitive advantage include?
Durable competitive advantages, or moats, can include factors such as:
- Cost-efficiencies, such as being able to create economies of scale or maintaining a geographically advantageous location to the market
- Customer loyalty, where the business has a vast consumer base who are not likely to switch to a competitor in the immediate future, either due to habit, effort involved to change, or financial downsides to changing
- Market monopolisation and network effects, where the business’ product or service offering is so dominant that customers have difficulty switching, or do not want to switch
- Patents and or licenses, where the business has a service or product that is difficult to obtain from a competitor
Pricing power
A great combination for a business worth investing in would be a business with a competitive advantage, a strong brand and good management. A business that has the ability to lift prices, increasing their margins, and enjoy sustainable sales growth – that is rocket fuel for earnings and share price growth.
If you would like to find out more on how to make the most of your financial assets, please contact me for a complimentary consultation at [email protected] or on (07) 3398 4888.
If you are interested in learning more about durable competitive advantage, I recommend the following books:
Competition Demystified by Bruce Greenwald and Judd Kahn
Competitive Strategy by Michael Porter