Key insights
- The article outlines an investment strategy focused on identifying companies with strong, multifaceted moats. It emphasizes the importance of both intangible assets and switching costs, particularly highlighting the role of competitive pricing as a key driver of customer acquisition and retention, potentially leading to increased pricing power. This suggests a bullish outlook for companies that can effectively leverage these factors to maintain market share and profitability.
Essentially, over time, I have taken Pat Dorsey’s moat blueprint and hardened it. I have some differences with him because I don’t think his approach goes far enough. This particularly applies to switching costs and determining what a “wide moat” actually is. To him, a wide moat is a company that possesses one perfect category from his list. To me, this isn’t good enough. I want a company that has a little of everything. He argues that a company just needs one, but I believe it is harder and more time-consuming for a competitor to attack from multiple areas, thus buying my company more time to compete head-on.
This is how I evaluate a moat. (I like structure, so I use a grading system for everything. I keep it simple: yes or no and move on. That’s just how I stay focused and to the point in investing.)
Intangible Assets: 5 pts -Strong brand: +1 pt -Wide range of active patents: Consistently producing and providing actual protection. +2 pts -Regulations/Licenses: Tough government regulations that force companies to spend months or years to obtain. You can’t start building military weapons tomorrow and sell them to the government. +2 pts
Switching Costs: 5 pts -Lower price than competitors: +3 pts. This is where I have a major difference with Dorsey. He views switching costs primarily as the "headaches" involved in switching away. I agree those are important, but I don't believe they are as critical as the actual price of the good. The price of a good is the number one driving force in a capitalistic market; it is the primary factor for someone deciding what and where to buy. I view pricing power as a bonus. Having a cheaper product often attracts customers to the point where a company can eventually start to increase prices while maintaining sales volume. -Headaches: +2 pts. Again, this is important to me, just not as much as the actual price. Forcing a company to change the software an entire office uses and retrain every employee overnight is a massive hurdle. Humans naturally crave consistency and familiarity.
Network Effects: 5 pts -Traditional/Tech Network Effects: These are the classic scenarios where the service becomes exponentially more valuable to every user as new users join. I score these higher because they are incredibly difficult to displace once they reach a tipping point. -Non-Traditional Network Effects: I reward up to 2** **points for non-traditional effects. These occur when bringing in more people helps customers individually rather than just collectively. Essentially, as the user base grows, the company can provide better data, lower prices, or faster service to the individual user.
Cost Advantages: 5 pts This category focuses on systems that allow a company to produce goods or services at a lower cost than their rivals, directly resulting in higher profit margins. This includes: -Economies of Scale: Being large enough to spread fixed costs over more units. -Cheaper Supplies: Having unique access to raw materials or favorable vendor contracts. -Vertical Integration: Controlling the supply chain to cut out the "middleman" and reduce production friction.
That’s how I evaluate moats. I want 14/20 pts, a great balance sheet, a great price. That’s a fat pitch.
Does this happen often? No. But when it does I swing at that fastball right down the middle .