An investment moat is the idea that a company has a defined and fixed edge against its competition and, as such, will continue to report superior growth and profits.
Such a moat could be a brand or, as was the case with SAB up to the 1990s, their delivery network that ensured their products were in every available outlet – making it really difficult for new entrants to break into the beer industry.
Often a moat can be technological, such as a patent. Or it can be legislative, such as a banking or exchange licence. It might even just be a superior product.
These moats give the company protection against competition, new and old. But they need to be watched carefully because, ultimately, any moat can be breached and that can have disastrous consequences.
A popular example is, of course, that of Kodak. They were the biggest player in the photography market (along with Fujifilm) not because they sold cameras, but rather because they sold and processed film.
So, regardless of which camera you owned, odds were you’d be using their services. As recently as 2005 they were still delivering quarterly revenue of over $3bn. Nowadays they do less than a tenth of that, having tried to pivot to digital cameras, tablets and even toying with crypto mining machines at one point.
The company still exists, and people are taking more photographs than ever before. But their technological and distribution moat is gone. The company is floundering as it tries going back to the film route by producing and developing 135 format and Super 8 format of Ektachrome film, now a very niche market.
The point is that sometimes the breaching of the moat arises from new technology, but it can also be as a result of the moat itself.
Think of a company that has a massive moat, which enables great profit margins. As an investor you’ll be making great returns. But, make no mistake, other companies are looking at their juicy returns and wondering if they can’t also get in on the game.
Locally, the JSE had an effective moat as the only exchange in South Africa. But, in the last few years, we’ve seen three new exchanges all come to market with cheaper offerings. This has seen the JSE having to improve its offering and reduce prices – both of which have been hurting margins.
So yes, a moat is a great investment, but it also invites new competition or can be eroded by new ideas and products. In fact, I’m not sure any moat can last forever.
With this in mind – what about a different type of moat that stems exactly from that heightened competition? For example, food retailing in South Africa is hugely competitive, with a few major retailers and thousands of smaller grocery stores.
It is also a very low-margin business that requires serious logistics and, to really boost efficiencies, you need a large footprint of stores to drive down costs and create price efficiencies. The moat here is that the small margins allow very little room for error and any potential competitor would be very hard-pressed to be able to compete as they ramp up to scale. So very deep funding pockets would be needed, and success may still be elusive. And that’s why it acts as such an effective moat.
Here the moat is not technology or licences. It is simply scale and competition that drive margins lower. For me this is often the better moat; breaching it is very hard and expensive, and fraught with the risk of failure. While the traditional moat has great margins, it has real risks of being breached as others try to get in on those margins.