4 False Moats That Make You Make Stupid Investment Decisions

Warren Buffet introduced the concept of economic moat. Moat, as a term refers to the dug up water filled area that surrounded medieval forts and castles to keep the enemy at bay. In the modern economic term, the spirit of this word remains same only it has entered companies’ board rooms and is an important part of long term strategies. An economic moat is the competitive advantage an entity has which keeps it safe from competition over a sustainable period of time. Now this does not mean that economic moat lends immunity but just a solid cushion that ensures its long term sustainability.


Why is a moat important for Investor?

Competition is probably the biggest threat to survival of any business. Even if the onslaught of competition is not be fatal, it can significantly reduce the profitability and market share resulting in shaky performance in stock markets. Moats reflect an advantage over competition and asserts leadership over a long term. It also means that competition will not be able to drive the company down suddenly. So the investment is safe on a long period of time frame. Such companies also build a great brand value which further fuels the share prices. This is why it is important for investors to understand the moats of the company they are going to invest in.
Moats cannot be black and white- what may work in favour of a company in a particular industry may not hold in another. Also, what may seem like advantage may not really reap benefits or thwart competitors. We are going to take a look at numerous advantageous positions that are presumed to be moats but do not end up being so.


Four misleading moats that you should be aware of  :

Company Size

savageminds.org

savageminds.org

 There is no denying that economy of scales works in favour of cost cutting but whether it does act as a moat is open for debate. Even if the size of the company is intimidating, it never dissuades competition from entering the market. In fact, unorganised sector in India is a big example of this situation. Look at the yellow taxi unions that are thriving across India and competing with big players like Ola and Uber. This goes on to show that being big may not keep competition at bay. In fact, sometimes big size may actually prove to be detrimental in term of costing of products since fixed expenses are really high and compliance related rules are much harsher. For example- chemical industry. The unorganised players in chemical sector can give a product at a much lower price point as compared to some of the most reputed global players like Dow. Of course, we are referring to general chemicals and not specialities. In the finance industry fintechs being much smaller and nimbler without the regulatory constraints are giving the larger banks sleepless nights. In the Airlines industry, Indigo with much smaller operations successfully fought much bigger rivals like Jet Airways and became the largest domestic airline. Lastly, who can forget the legendary Karsan Bhai Patel who began selling washing powder on the back of his cycle and went to establish Nirma as the largest selling washing powder brand in the world; successfully beating HUL and other large FMCH companies.  
Exception: A big competitor with deep pockets can create disruption in the industry. Reliance Infocomm with its Monsoon Hungama offer sent shockwaves in the telecom industry earlier. Reliance Jio is trying to recreate the magic with the 4G offering and is gaining success. In the e-commerce space, the entry of Amazon has started the wave of consolidation in India.

Huge market Share

variety.com

variety.com

Quite contrary to usual perception, when one or two companies enjoy maximum market share, it usually attracts competition as the sector looks unsaturated. If the market size itself is huge then there is no telling how many competitors will enter the market and erode market share of a present market leader. Consider the case of Micromax, it entered Indian mobile phone market in 2008 and by 2015 it was already challenging the biggest Mobile phone maker Samsung. Cut to 2016, Micromax spiralled downwards and lost more than 50% of its market share in a matter of year! So what went wrong? While Micromax was getting its handsets made from Chinese manufacturers like Oppo and Coolpad, these manufacturers were eyeing the Indian markets. Last year they entered the Indian markets wreaking havoc on the existing players. Even Samsung is on a slide since then! Another global example of this false moat happen to be Nokia and blackberry who sort of packed their operations overnight from being the best and biggest! Patanjali products carving a sizeable market share in the toothpaste, soaps, and many other FMCG categories in a short span of time is also a good example.

Efficient management:

procurious.com

procurious.com

Lets face it- there is no dearth of talent and talented people in the market. Qualified personnel with great experience are available for the right money. Also a company boasting of having the best management amongst the industry can lose it really fast. Haven’t we heard of the best CEOs changing companies overnight (all for a better price or opportunity)?
At the end of the day, people are people and they need to take decisions. Now these decisions can sway either way and there is no telling whether the impeccable track record of some members of the management would keep holding for long. Look at Cyrus Mistry, the golden boy of Tata group now facing ire of his own management and board. The earlier example of Micromax also has a thing or two to speak about people. Apart from being blindsided, tiff between its founders and executives has been one of the biggest reasons behind downfall of Micromax. Simply put, people cannot be moat because:
1)    They are replaceable
2)    Their decisions are influenced and biased
3)    They tend to move from one entity to other for better personal and professional opportunities
4)    People may influence success of a company but cannot guarantee it.
5)    Just because one entity has an efficient management does not mean that another cannot.
6)    Just because management has succeeded in one line of business doesn’t mean that it can success in another business. Business dynamics differ and as Buffet maintains, between bad business and great management, it’s the bad business that usually wins.

Good products

news18.com

news18.com

Good products are definitely great selling points and bring in revenues but remember someone will create a better product overtime and then your good product will go down the drain along with revenue flows. In fact if you have launched a super successful line of products then it is most likely to attract competition and replication. And the one example that we can think of it right now is Domino’s Pizza and US Pizza. Way before domino’s or even Pizza Hut, US Pizza had recognised the need of introducing Indian toppings on their pizzas to make them appealing for Indian market. So came Tandoori Chicken pizzas and other similar flavours. Needless to say, it was successful and this was closely followed by Domino’s. Even if US pizza had an upper hand over other pizza makers, it was there only for a very short time. Today Pizza Hut is the biggest pizza vendor in India followed by Domino’s and they still keep introducing new Indian flavours and toppings on their pizzas.

Moats that work and matter

It has been a long list of moats that don’t work so what really construes as a genuine moat? The answer is rather simple to state- it is something that your competitors cannot replicate in a short period of time and without a huge expense. This brings us to valuable intangible assets that a company holds in form of brand value, copyrights, patents, secret recipes and trademarks. These assets actually lend amazing edge to companies over their competitors. Even if competitor is able to catch up, it takes years and by then the brand and reputation of the product is already built. When Nestle Maggi suffered a setback after it was claimed that it was harmful for consumption, people thought that it would be the end of it. Many other brands like Yipee, Patanjali atta noodles and Horlicks jumped at the opportunity to market and introduce their products in the market aggressively. However, once Maggi got back into the market, it was back to square one! The brand is by now so powerful and people so used to its taste that for any other noodle maker it is out and out uphill battle. In India, Software companies can apply for patents only in cases where product is an amalgamation of software as well as hardware. Any product that is purely software based will be denied patent but shall be protected by copyright. This should provide a lot of moat cushioning to existing players with patents in their kitty!
Apart from Copyrights, patents and brands, Proprietary processes can make a lot of difference on the quality and cost of final product. If your process is protected and can offer what none other can, then it qualifies as a wide moat.
End to end network like the one Coca Cola has in India is also a great competition barrier. Right from manufacturing to distribution, Coca Cola is able to control costs and distribution across India. They acquired this horizontal specialisation by taking over an existing iconic Indian brand Thums up. Even though Thums up still remains a more popular and loved brand out of all Coca Cola offerings in Indian market, all the network that came with Thums up actually gave it a definite upper hand and continues to do so. Closer home, it is hard to match the distribution reach and network of the Shriram Transport Finance. GE Finance tried to enter the space but could never achieve success. Again UPS with its global network, and Walmart with its huge well-oiled Supply Chain network are difficult to replicate.

Twelve Companies that have strong moats:

Here are twelve companies that we think have strong moats. The companies are arranged in no particular order. This list should not be construed as an investment advice.

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