Can Lean business model become your economic MOAT ???

What Is an Economic Moat?

The term "economic moat," popularized by?Warren Buffett, refers to a business's ability to maintain competitive advantages over its competitors in order to protect its long-term profits and?market share. Just like a medieval castle, the moat serves to protect those inside the fortress and their riches from outsiders.

KEY TAKEAWAYS

• "Economic moat" is a term that refers to a business's ability to maintain a competitive edge over its competitors.
• The analogy relates to the moats that would surround medieval castles and act as a barrier of protection.
• Ways in which a company can create an economic moat include creating advantages in size, intangibles, cost, and high switching costs.
• The term economic moat was made popular by legendary investor Warren Buffett.

Creating an Economic Moat

There are several ways in which a company creates an economic moat that allows it to have a significant advantage over its competitors. Below, we will explore some different ways in which moats are created.

Cost Advantage?

A cost advantage that competitors cannot replicate can be a very effective economic moat.

Companies with significant cost advantages can undercut the prices of any competitor that attempts to move into their industry, either forcing the competitor to leave the industry or at least impeding its growth.

Companies with sustainable cost advantages can maintain a very large market share of their industry by squeezing out any new competitors who try to move in.

Size Advantage

Being big can sometimes, in itself, create an economic moat for a company. At a certain size, a firm achieves?economies of scale. This is when more units of a good or service can be produced on a larger scale with lower input costs. This reduces overhead costs in areas such as financing, advertising, production, etc.

Large companies that compete in a given industry tend to dominate the core market share of that industry, while smaller players are forced to either leave the industry or occupy smaller "niche" roles.

High Switching Costs?

Being the big fish in the pond has other advantages. 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.

Intangibles?

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. Strong brand name recognition?allows these types of companies to charge a premium for their products over other competitors' goods, which boosts profits.

Soft Moats?

Some of the reasons a company might have an economic moat are more difficult to identify. For example, soft moats may be created by exceptional management or a unique corporate culture. While difficult to describe, a unique leadership and corporate environment may partially contribute to a corporation's prolonged economic success.?

Economic moats are generally difficult to pinpoint at the time they are being created. Their effects are much more easily observed in hindsight once a company has risen to great heights.

From an investor's view, it is ideal to invest in growing companies just as they begin to reap the benefits of a wide and sustainable economic moat. In this case, the most important factor is the longevity of the moat. The longer a company can harvest profits, the greater the benefits for itself and its shareholders.

What Is an Example of an Economic Moat?

One example of an economic moat is economies of scale. As a company achieves economies of scale, it can produce each unit for less than it could before, meaning that it can charge less for that product in the marketplace, which would attract customers and undercut competitors.

What Are Some Ways to Identify an Economic Moat?

When evaluating a company and its economic moat, a few questions should be considered, such as, what are the sources of revenue for the company?; of these sources, which is the cash cow?; what is the industry of the company?; who are the competitors in this industry?; and what is the company doing to stand out out from its competitors?

What Is Apple's Economic Moat?

Apple has a few economic moats, the primary one being creating products that did not exist before, such as the iPod, the iPhone, and the iPad. After the creation of those products, Apple's economic moat has consisted of its marketing, its design, and its user-friendly interface.

The Bottom Line

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.

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