Economic Moat and Importance in Finding One

Economic Moat

Lucrative businesses continue to offer goods and services their customers need and provide multiple options to access. The question is how do they do this? When I was a young boy, I remember there was a store in my hometown. The store was called Lerch & Daly and predominately offered men’s clothing. Lerch & Daly had been around for nearly 100 years at that time. Think about that almost 100 years! By the time I reached high school, the business was about ready to close their doors. What happened? The business thrived in a time where the only way to get men’s clothing was for it to be easily accessible. When the store started, the automobile was just invented and traveling required either walking or by horse and carriage. You worked where you lived, and you did not have time to go to far to find clothing. Lerch & Daly was smartly located right in the heart of downtown where you could easily access. As the 20th century progressed we say continual easy to travel by automobile, bus, airplane, and faster train service. Cities like my hometown continue to grow at an exponential rate, and eventually, more stores existed like Lerch & Daly not just in my hometown, but also with a radius where day travel was possible. The final blow was the Internet this provided a multitude of options for clothing. I used this store as an example, but basically, all the stores that were open downtown from the time I was five to I graduated high school closed. The number would consist of about 10-15 long running businesses. Why am I sharing this story? You can attribute Lerch & Daly success to their economic moat. The stores in the early 1900’s were local and without a competitor in some cases. Once local became unimportant, and competition increased the stores failed to keep their doors open.

What is an economic moat?

By definition, an economic moat is a business’ ability to maintain competitive advantages over its competitors to protect its long-term profits. This idea is always silently expressed on ABC’s Shark Tank, a television show where aspiring entrepreneurs’ look for funding from six angel investors for their business or product. After several pitches from fund seekers, the predominant factor in their pitches success is future profitability and achievement based on whether they currently have an economic moat. If you don’t, believe me, watch an episode and see how unsuccessful businesses are in achieving funding when they operate in an industry like food or electronics. Only when they offer something you can’t get anywhere else, or a bigger company cannot quickly replicate are their pitches successful. The previous sentence brings up the question what happens when you lose your economic moat? Could Lerch & Daly have survived? There is nothing understood about their supplier and the cost of selling goods, the want of their owners to continue the business and find another economic moat. I have noticed 20 years later local businesses reappearing in smaller downtowns. The idea of supporting locally owned stores that sell locally produced goods and services. The economic moat, in this case, is being local. Could Lerch & Daly have changed their product line only to include local products and have been successful? Could Lerch & Daly have started a website? Remember a moat is offering anything that can maintain a competitive advantage. Again this is just a plausible idea I’m sure there are others out there, but an interesting question.

How to build a moat?

The key to building an economic moat is maintaining a competitive advantage. A competitive edge is as simple as offering a product line that no one else is offering as mentioned above. But, this is easier said than done. How do you find a competitive advantage and then maintain that position? Let’s take something innocent and simple like a lemonade business. Young children’s first introduction to business in the past has been this route. Why is this the case and these companies moderately successful? Lemonade is readily accessible and can be made by anyone, meaning there is no need to pay someone in theory. The competitive advantage the child has a demand to stay cool on a hot summer day and an inexpensive price, which is usually a dime or a nickel. A restaurant or storefront would charge near a dollar or more for a glass of lemonade. The main competitive advantage is the price. A larger and clearer example is Wal-Mart, who provides lower prices than their competitors due to their cost advantage. Wal-Mart has forced many companies over the years to put up a “Going Out of Business” sign. An economic moat can be cost advantage, size advantage, high switching cost, or offering a unique product or service no one can replicate.

Unique Product or Service

An artist works are unique to them, and copyright protects any attempt to replicate. Documentation of copyright protection for graphic artists in the media is non-existent. However, this is always documented in the case of musicians. Robin Thicke for his song “Blurred Lines” which was found liable for using copyright material from a Marvin Gaye song without citing his work and Sam Smith who settled out of court with Tom Petty for his song “Stay with Me.” The point is the artist has the protection of copyright and as a designer and inspiring musician this is comforting. A unique product example could be a whale burger with a secret sauce. Yes, I said fish burger I am not advocating you go out and do that my allergy to fish means I would be making let alone eating. You may be inclined if you are a homeowner to higher a reputable roofing company for a new roof. Most of these types of services survive based on client reviews and endorsements of their work. Other customers are acquired; because they only want to work with them meaning their economic moat is their work and ability to please their clients. If their company is sold hypothetically to a business outside the area, they will lose their moat. The company would lose sales in the short term until the outside company could build a brand in the particular geographical area. A good example is the famous Chicago pizzeria, Uno Pizzeria & Grill, opened up a restaurant in Buffalo, but was unable to survive. In an industry like pizza the market is robust and local pizzerias flourish, because their economic moat is a distinct taste only to that pizzeria. Pizza has the same ingredients, but rarely does any pizza taste the same as another. A cautionary tale as businesses specifically in the food industry have thousands of competitors, and building a brand in a flooded industry is not plausible.

Cost Advantage

I previously mentioned Wal-Mart’s success due to their cost advantage and led to their ability to maintain a considerable market share of their industry. Cost advantage allows you the ability to undercut competitors from relics of the past like Montgomery Ward to local stores like Lerch & Daly. I am not saying that Wal-Mart was the primary reason Lerch & Daly closed. We did not have a Wal-Mart until a few years later. There were other retailers like Sears that used this model.

Size Advantage

Startups and new companies need to find a niche to gain a foothold in that particular market. Big companies have more resources, lower expenses for advertising, marketing, and production. Businesses larger in size can do more and faster than a startup. Trying to compete head-to-head offering the same product is not wise. A big company’s moat is that they are big.

High Switching Cost

Once you have established yourself in your industry by gaining a market share of the business, you can prevent losing customers with implementing a high switching cost. A good example would be wireless telecommunications companies who force you to sign a multi-year contract with the purchase of a cell phone for cellular service. In the event, you decide to leave let’s say AT&T Wireless for competitor T-Mobile before the end of your contract. You encounter a steep fee to change providers. However, in this example, T-Mobile has offered to pay the fee for you.

Top Economic Moat Companies

Here are some of the top companies in their particular markets. Each was has carved out a moat in their industry. Each one of these companies has developed an economic moat that allowed them to reach the top.

Aerospace – Boeing
Apparel, Footwear – Nike
Computer Hardware – Lenovo & HP
Credit & Debit – American Express and Citi Corp
Department Stores – Macy’s and Sears
Food Manufacturing – Nestle & Pepsi Co.
Internet Media – Google
Mass Merchants – Wal-Mart
Retail Discretionary – Home Depot & Amazon

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