Business

Economic Moat: Understanding the Concept 

An “economic moat” is a business’s capability to sustain a competitive advantage over its competitors. This moat helps protect the company’s long-term profits and market share. Popularized by Warren Buffett, the legendary Cryptocurrencies News investor, an economic moat protects those inside the “castle” against invaders. 

How to Build an Economic Moat? 

Companies use a variety of ways to create an economic moat. These methods allow them to gain certain advantages against rivals. 

What are the ways companies create moats? 

Cost Advantage 

A cost advantage, if competitors cannot copy it, can be a very protective economic moat. 

Firms with huge cost Forex Brokers List advantage can undercut the prices of any rival that tries to join the game. They can either force the entrants to leave the space or stunt its growth. 

Companies that have sustainable cost advantages can maintain huge market share of the industry by effectively beating any new rivals who try to enter the industry. 

Size Advantage 

Sometimes, the sheer size of a company can be an economic moat in itself.

At a specific size, the company achieves the so-called “economies of scale.” This feature comes when the company can produce more units of a good or service on a larger scale with lower input costs.

The company then benefits from lower overhead costs in areas like financing, production, advertising, et cetera. 

Extremely large companies tend to dominate the core market share of a given industry. Smaller players then have no choice but to either leave the industry or occupy smaller “niche” roles. 

High Switching Expenses 

And if the company is considered the “biggest fish” in an industry, it also enjoys other benefits. 

When the company establishes itself in an industry, suppliers and customers can be subject to higher switching costs should they want to do business with another competitor.

In other words, smaller competitors find it difficult to take away market share from the industry’s big fish because of the hefty switching costs. 

Intangibles 

Companies can also gain an economic moat through their intangible assets. Such assets include patents, brand recognition, government licenses, and others.

Strong brand name recognition lets the companies charge a premium for their products over other competitors’ goods. This, of course, boosts profits. 

Soft Moats 

Other reasons a company may be benefitting from an economic moat can be a bit difficult to point a finger on. 

For instance, soft moats can be created by excellent management or a unique corporate culture.  

Although it’s difficult to describe, a unique kind of leadership and corporate environment may partially contribute to a corporation’s extended economic success. 

In general, economic moats are difficult to pinpoint at the time they are being created. We can usually see the effects of such moats in hindsight once a company has achieved great success. 

For an investor, it is ideal to invest in growing companies as they are starting to reap the benefits of a wide and sustainable economic growth.  The more the company can harvest profits, the more benefits the shareholders get. 

 

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