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Today I’m going to talk about the different types of moats a business can have.
A moat is formed around a business when it fulfils Value Investing Principle #2: The business has a natural quality to it that provides an advantage for it. To read more about how you can tell if a business meets principle #2, check this article out. A moat circles a business giving it an advantage which makes it difficult for other businesses to attack it. Some businesses have more than one type of moat. There are 5 types of moats:
Brand Moat A brand moat is quite a powerful moat. Businesses that have this moat are often referred to by the business name - you don’t refer to your cellphone as a smartphone, you call it an iPhone, or you ask for a Kleenex, not a tissue. Coca-cola, Tesla, Amazon, Lululemon are just a few businesses that come to mind that have a brand moat. Switching Moat A switching moat makes it difficult for the customer to switch to another business from their product. You buy one product from this business and then it’s so integrated into your life that when it comes time to buy accessories or replace it, you’re stuck with purchasing from the same business. This is accomplished by the business as it won’t allow other companies products to be compatible or you’re not willing to go through the trouble and headache to start from step 1 one something new. Toll Bridge Moat A toll bridge moat requires the customer to pay for its services, which isn’t unique for a business. The catch is, the business providing the service will likely be one of the few, if not the only one business providing that service thus giving them a monopoly on that industry. Sometimes there’s government regulations or rules that support the use of that business. Think of the utility company or the railroad industry. Secrets Moat A secrets moat means a business has information that they use for their product that no one else knows. And having this patent, or trade secret is critical for the production of their product. This is very common in the pharmaceutical and technology industry. Even Coca-Cola holds their recipe very near and dear to their heart. Price Moat A price moat promises to provide its products at a lower cost than its competitors. Think of the big box stores and how the local “mom and pop” shops struggle to compete. Providing products at the lowest price will draw customers in. When a business has one of the 5 moats, it's wise for it to try to protect its moat. To make it sustainable so it’ll last. When you are choosing which business to invest in, you don’t want the moat to crumble as that’ll have a direct impact on how successful (or not successful) the business will be in the long run. If you’re curious how to determine if a business has a moat, versus just guessing, check out my last article here.
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