Monday, January 28, 2008

Four types of moats

Recently on the Motley Fool, there was an article highlighting four different moat types:

  1. Economies of scale
  2. The network effect
  3. Intellectual-property rights
  4. High switching costs
Personally, I'd divide IP rights into: patents/secrets and brands, which is to say: what you know and what your customers know. Also, economies of scale and network effect are really two sides of the same coin. Size can give a company advantages or it can give customers advantages or both. I think high switching cost has an analogue as well: monopoly. Regulated monopolies are especially impervious to assault.

  1. Size
    1. Economies of scale
    2. The network effect
  2. Knowledge
    1. Intellectual-property rights
    2. Brand
  3. Stickiness
    1. Monopoly
    2. High switching costs
In each case, the moat is developed by created an advantage that other companies can't steal. Bigger companies, like bigger ancient cities, are more likely to have established moats. For instance Oracle, Canon and Berkshire Hathaway have multiple and deep moats in nearly every category. First Marblehead mostly fends off competition with intellectual property. I'm worried that Select Comfort might have lost their primary moat—their brand. Those are much smaller companies that have not completely staked out their territory.

So for smaller, fast-growing companies, the question is what moats can they develop?

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