Competitive Advantage Part 1

Competitive Advantage Part 1

In general there are 5 ways for a company to build a competitive advantage over its peers. Warren Buffet calls this competitive advantage as “economic moat”. An economic moat is the ability of the company to keep its competitors at bay from hurting its profits.

The wider the moat, the longer the company can protect its profits. The deeper the moat, the more profitable is the company.

A company can build its competitive advantage in one or more of the following ways.

  1. Product differentiation. – Market Leader in new innovative products
  2. Branding. – leading to customer loyalty
  3. Low costs or prices. Huge Economics to Scale
  4. Locking in customers. – High Consumer Switching Cost
  5. Locking out competitors. – High Barriers to Entry (patent, legal)

Product Differentiation

A company could produce and market a product with superior technology or features not found among its competitors. And usually these products are introduced to the market at a premium price, which makes the products very profitable. There are customers who will be willing to pay more to get products with the latest technology or best features.

Unfortunately, this type of competitive advantage is usually short-lived. Technology is constantly advancing and today’s market leader could become obsolete tomorrow. Competitors are always churning out superior products by adding or improving features. In short, it is difficult to constantly stay one step ahead of the competitors.

Although companies can occasionally generate excess profits by staying one step ahead, these profits are however, not sustainable. We call this competitive advantage a narrow economic moat.


Branding

The advertising industry is a multi-billion dollar industry. Companies spend enormous amount of money to build their brands. The aim is to deliver the message that their products or services are better than the competitors.

A strong brand can be a wide and deep economic moat. Consider designer label apparel and accessories. People are willing to pay much more for the branded apparel than an identical item minus the brand that is selling in the local store.

And as long as people perceive that the items associated with the brand is of superior quality, it doesn’t really matter if the product is actually better or not. This fact that people are willing to pay more is what defines the value of the brand. A brand that can significantly increase profit margin is known as a deep economic moat.

Not all strong brands can help boost profitability. Brands are not useful in some industry. Consumers are unlikely to pay much more for a branded computer than a clone computer with the same specifications and features.

Assessing brands this way helps to separate valuable brands and less valuable brands. A brand that lasts for a long time will create a wide economic moat.

We will discuss the other 3 in the next posting.

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Mind Kinesis Research Team
Investment in Stocks Blog
Value Investing Academy – the Warren Buffet Way
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