Latest / The Dutch Investors / #16 | Understanding moats | What they are, why they matter and how to spot them

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#16 | Understanding moats | What they are, why they matter and how to spot them · The Dutch Investors

• 0:00
  SPEAKER_00: Welcome back everyone to another episode by the Dutch Investors Podcast.
• 0:05
  SPEAKER_00: Today we're diving into one of my favorite topics: economic modes, also known as competitive advantages.
• 0:13
  SPEAKER_00: It's a concept that ties together business strategy, competitive dominance, and of course investing.
• 0:19
  SPEAKER_00: Whether you're a casual investor or someone who tracks the market like a hawk, understanding modes can be the difference between good investments and legendary ones.
• 0:30
  SPEAKER_00: So let's talk modes, what they are, why they matter, and how to spot them.
• 0:45
  SPEAKER_00: Picture this.
• 0:46
  SPEAKER_00: Back in medieval times, castles had moats.
• 0:50
  SPEAKER_00: The wider and deeper the moat, the harder it was for invaders to get in.
• 0:56
  SPEAKER_00: The same goes for businesses today.
• 1:00
  SPEAKER_00: Companies with strong modes can fend off competition, protect their profits, and thrive in both good and bad times.
• 1:10
  SPEAKER_00: Now I know some of you are probably thinking of companies with massive modes.
• 1:19
  SPEAKER_00: I mean those are the classics, right?
• 1:21
  SPEAKER_00: Or in the luxury space, Alfie Mage, Hermes, Ferrari.
• 1:27
  SPEAKER_00: But before we dive into the specifics, let me drop some wisdom from the one and only Warren Buffett.
• 1:34
  SPEAKER_00: The key is not assessing how much an industry will affect society or how much it will grow, but rather determining the competitive advantage of any given company, and above all, the durability of that advantage.
• 1:51
  SPEAKER_00: Today we're exploring one of the most powerful concepts.
• 1:54
  SPEAKER_00: Modes are competitive advantages, like I said, that protect companies from rifles and keep their profits flowing year after year.
• 2:03
  SPEAKER_00: At least, that's the idea.
• 2:05
  SPEAKER_00: Today we'll dive into seven, perhaps even a little extra mode, we believe is just as important.
• 2:12
  SPEAKER_00: We'll look at what makes each mode powerful, their strengths, weaknesses, and of course a lot of examples.
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  SPEAKER_00: Plus, we'll wrap up with why modes are so essential.
• 2:23
  SPEAKER_00: Alright, let's get started.
• 2:26
  SPEAKER_00: First up, mode 1, Economies of Scale.
• 2:31
  SPEAKER_00: One of the most straightforward but effective modes.
• 2:35
  SPEAKER_00: And this mode occurs when a company reduces its cost per unit as it produces more.
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  SPEAKER_00: It's like making soccer balls, for example.
• 2:46
  SPEAKER_00: If a factory produces a thousand balls, each one might cost$10 to make.
• 2:52
  SPEAKER_00: But if they produce 10,000, the cost drops to$1 per ball, because the fixed costs, say rent or machinery, are spread out.
• 3:05
  SPEAKER_00: So why does this matter?
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  SPEAKER_00: Companies with economies of scale can charge lower prices, which attracts more customers, and squeeze out smaller competitions who can't match their costs.
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  SPEAKER_00: Think about Amazon's fulfillment network, for example.
• 3:23
  SPEAKER_00: Their massive warehouses and logistics systems let them ship millions of products at costs smaller retailers can touch.
• 3:32
  SPEAKER_00: Or Netflix, whose huge subscriber base allows it to spread the cost of producing hit shows like Stranger Things or Squid Game across millions of users.
• 3:44
  SPEAKER_00: Or what about Walmart, IKEA, Costco, Ryanair, or even Microsoft all benefits from this specific mode.
• 3:54
  SPEAKER_00: There is a downside.
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  SPEAKER_00: Companies relying too heavily on scale can run into diseconomies of scale.
• 4:03
  SPEAKER_00: Like inefficiency or bureaucracy.
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  SPEAKER_00: And as they grow too large, this will slow them down.
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  SPEAKER_00: Think of General Motors or Volkswagen.
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  SPEAKER_00: They have learned this the hard way.
• 4:18
  SPEAKER_00: Another mode is network effects.
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  SPEAKER_00: And this one is probably familiar to most of you, so I'll try to keep this one short.
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  SPEAKER_00: This is a mode where the value of a product increases as more people use it.
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  SPEAKER_00: The classic examples are social media platforms like Facebook or LinkedIn.
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  SPEAKER_00: The more people join, the more valuable the platform becomes for everyone.
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  SPEAKER_00: Or consider Uber.
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  SPEAKER_00: More drivers means shorter wait times for riders, which attract more users, which then draws even more drivers.
• 4:51
  SPEAKER_00: But there is a catch.
• 4:53
  SPEAKER_00: Network effects can fade if a company doesn't innovate.
• 4:57
  SPEAKER_00: Perhaps MySpace rings a bell.
• 5:00
  SPEAKER_00: Also, malicious actors like fake accounts or spammers can weak and trust in a network, as we've seen with Facebook in recent years.
• 5:10
  SPEAKER_00: Other examples of companies with strong network effects are Duolingo, Amazon or Airbnb.
• 5:17
  SPEAKER_00: Or what about YouTube?
• 5:20
  SPEAKER_00: Those have exceptional network effects as well.
• 5:23
  SPEAKER_00: The next mode are switching costs.
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  SPEAKER_00: Switching costs create a mode by making it expensive or inconvenient for customers to switch to someone else, a competitor.
• 5:36
  SPEAKER_00: Think about Adobe's Creative Cloud.
• 5:39
  SPEAKER_00: If you've spent years mastering, say Adobe Premiere Pro or Photoshop and storing projects on the Adobe platform, switching to another tool, say Canva for example, would mean losing time, files, and perhaps even productivity, because you have to spend a lot of new time and effort into learning a new tool.
• 5:59
  SPEAKER_00: The strength here is customer loyalty.
• 6:02
  SPEAKER_00: But there is a risk with this one.
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  SPEAKER_00: A competitor offering a simpler, more affordable alternative can disrupt this market.
• 6:11
  SPEAKER_00: Remember when Google Docs opened it for free and challenging Microsoft Office with Word.
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  SPEAKER_00: Switching costs protect profits until they don't.
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  SPEAKER_00: Other examples of switching costs could be Spotify.
• 6:26
  SPEAKER_00: Think of all your personalized playlists that took years to build.
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  SPEAKER_00: Apple's ecosystem.
• 6:32
  SPEAKER_00: I mean our analyst Luke just moved from Android to Apple and it's been a huge pain, he said.
• 6:37
  SPEAKER_00: But vice versa is true as well.
• 6:40
  SPEAKER_00: Or what about Intuit?
• 6:42
  SPEAKER_00: Try migrating all of your financial records to someone else.
• 6:46
  SPEAKER_00: Switching costs can be very strong, but there is a limit where customers will switch, so be aware of that.
• 6:54
  SPEAKER_00: Next up, cost advantages.
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  SPEAKER_00: A classic but powerful mode, and and you could list cost advantages under economies of scale.
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  SPEAKER_00: This is when a company can produce goods or services at a lower cost than anyone else.
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  SPEAKER_00: It is a bit different from economies of scale.
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  SPEAKER_00: Think Walmart, with their massive size and relentless focus on operational efficiency.
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  SPEAKER_00: Orionair, which keeps costs down by flying a single aircraft model and using secondary airports.
• 7:25
  SPEAKER_00: Cost advantages allow companies to undercut rifles on price or maintain higher margins at the same price.
• 7:34
  SPEAKER_00: It's especially effective in industries like retail, where margins are thin and going from 1 to 2% means doubling your profits, and customers here are usually pretty price-sensitive.
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  SPEAKER_00: There is a downside, because cost advantages depend on scale and efficiency, which can be vulnerable to technological disruptions or changing market conditions.
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  SPEAKER_00: For example, Tesla's focus on EV efficiency disrupted traditional outdoor makers reliant on economies of scale in gas-powered vehicles.
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  SPEAKER_00: To assess a company's cost advantage, look for signs like consistent profit margins, lower production costs, or strong supply relationships.
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  SPEAKER_00: Compare the margins to competitors.
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  SPEAKER_00: Companies that master cost efficiency, like Costco and IKEA, often dominate the industries for decades.
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  SPEAKER_00: Other examples could be AWS, Toyota, Simax, or even Audi.
• 8:38
  SPEAKER_00: Okay, next one.
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  SPEAKER_00: Next up, intangible assets, and I know this one is perhaps a bit more abstract.
• 8:47
  SPEAKER_00: Assessing the value can be pretty different between you and me.
• 8:52
  SPEAKER_00: Intangible assets include patents, brands, regulatory licenses, or proprietary technology.
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  SPEAKER_00: Things that can't be touched but drive immense value.
• 9:04
  SPEAKER_00: Take brands, for example.
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  SPEAKER_00: They're more than just a slogan or a logo.
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  SPEAKER_00: They're trust and identity.
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  SPEAKER_00: They stand for something.
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  SPEAKER_00: So why do people pay premium prices for a Starbucks coffee or a Tiffany ring, even when cheaper options exist?
• 9:24
  SPEAKER_00: It's the emotional connection and perception of quality.
• 9:28
  SPEAKER_00: And sometimes the quality is really a lot better, but that's a different point.
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  SPEAKER_00: A strong brand like Hermes or Apple can command loyalty and pricing power for decades.
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  SPEAKER_00: Patents are another example.
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  SPEAKER_00: They provide a temporary monopoly, letting companies like Eli Lilly, Novo Nordisk, or ASML protect their cutting-edge technology or patents, and this mode ensures competitors can't replicate their products without years of effort and billions of dollars.
• 10:02
  SPEAKER_00: Then there are regulatory licenses, like those in the Macau casino industry.
• 10:08
  SPEAKER_00: For companies like Win Resorts, these licenses create enormous barriers to entry, guaranteeing profitability as long as the rules don't change.
• 10:19
  SPEAKER_00: Another one is proprietary technology, and customer relationships are vital here.
• 10:24
  SPEAKER_00: Think Google's algorithm or Amazon's Prime Ecosystem.
• 10:29
  SPEAKER_00: These assets are nearly impossible to replicate and keep customers coming back.
• 10:35
  SPEAKER_00: Another great example is of course ASML's proprietary EUV technology, and no one has been able to even come close to that just yet.
• 10:45
  SPEAKER_00: Other examples could be Disney, think theme parks and movies.
• 10:49
  SPEAKER_00: Coca-Cola with decades of marketing that basically appeals to almost everyone nowadays, just to name a few.
• 10:57
  SPEAKER_00: Next one is process power, which might sound less glamorous than patents and brands, but is no less powerful.
• 11:05
  SPEAKER_00: This is when companies' internal culture, processes, or organizational structure allows it to consistently deliver better, cheaper, or faster results than competitors.
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  SPEAKER_00: It's about doing the same things, but better.
• 11:21
  SPEAKER_00: And I think the best example would be Nvidia.
• 11:25
  SPEAKER_00: Another example could be Amazon, with its Amazon's culture, built around the 16 leadership principles by Jeff Bezos.
• 11:33
  SPEAKER_00: They ensure relentless focus on innovation, efficiency, and customer satisfaction.
• 11:41
  SPEAKER_00: Their hiring practices, like the famous Bar Racer interviews, create high performance environments.
• 11:48
  SPEAKER_00: Similarly, Archen and Stripe have won developers' hearts by perfecting the little details: documentation, testing, ecosystem, and integration.
• 12:00
  SPEAKER_00: It's no wonder businesses find their tools so intuitive.
• 12:05
  SPEAKER_00: The magic of process power is that it's incredibly hard to replicate.
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  SPEAKER_00: A competitor can't simply copy Amazon's leadership principles or someone's team structure.
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  SPEAKER_00: It's embedded deeply within the DNA of these companies.
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  SPEAKER_00: This is why certain CEOs are so incredibly important.
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  SPEAKER_00: Jensen Huang is so important for Nvidia and he embraces process power.
• 12:32
  SPEAKER_00: There is a challenge for these companies because maintaining these processes as they scale is very hard.
• 12:39
  SPEAKER_00: Curture can weaken and operational excellence can slip if not carefully nurtured.
• 12:45
  SPEAKER_00: Other examples could be Netflix, Toyota, Southwest Airlines, or TSMC.
• 12:52
  SPEAKER_00: Okay, let's talk about cornet resources, one of the most durable and fascinating modes.
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  SPEAKER_00: This occurs when a company secures exclusive access to a valuable asset, whether that's raw materials, talent, technology, or intellectual property.
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  SPEAKER_00: By locking down these resources, companies create a competitive edge that it is very hard to replicate.
• 13:21
  SPEAKER_00: Take the beers, for example.
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  SPEAKER_00: For decades they controlled a huge portion of the global diamond supply, creating an artificial scarcity that allowed them to dictate pricing.
• 13:37
  SPEAKER_00: Their control over diamond mining, cutting, and distribution gave them a resource mode so strong that even competitors with access to diamonds struggled to compete.
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  SPEAKER_00: ASML, a favorite Dutch company, is another standout.
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  SPEAKER_00: They're the only company in the world capable of producing EUV lithography machines.
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  SPEAKER_00: The technology critical for manufacturing advanced semiconductors.
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  SPEAKER_00: Without ASML, chipmakers like TSMC and Samsung couldn't produce the cutting-edge chips used in smartphones, computers, and cars today.
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  SPEAKER_00: This exclusive access to technology creates an almost impenetrable mode.
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  SPEAKER_00: And of course, there is Disney, which has cornet the world's most beloved intellectual properties, from Star Wars to Marvel to its own classic characters.
• 14:34
  SPEAKER_00: Disney's content library is another exceptional good example of a cornered resource.
• 14:40
  SPEAKER_00: Other examples could be Rolls-Royce, Aerospace, Jet Engine Technology, perhaps Caterpillar and John Deere, or, like I said, certain mining companies that have exclusive contracts to mine in certain areas.
• 14:56
  SPEAKER_00: Very hard to replicate.
• 14:58
  SPEAKER_00: Next up, counterpositioning, a strategy where a new player disrupts an industry by radically different business models that established players can't adopt without hurting themselves.
• 15:12
  SPEAKER_00: Think Spotify.
• 15:14
  SPEAKER_00: By introducing subscription-based music streaming, it upended traditional record sales and made it very hard for companies like Apple and Labels to adjust without cannibalizing their existing revenue streams.
• 15:28
  SPEAKER_00: Apple adapted, but many others didn't.
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  SPEAKER_00: Another example is Airbnb.
• 15:34
  SPEAKER_00: Counterpositioning is a brilliant but temporary.
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  SPEAKER_00: Once the new model becomes the norm, the advantages do fade over time.
• 15:45
  SPEAKER_00: That's why successful disruptors like Spotify and Netflix transition to other modes, such as switching costs or exclusive content to maintain their edge.
• 15:57
  SPEAKER_00: For incumbents facing counterpositioning, the response often involves differentiation or adaption.
• 16:04
  SPEAKER_00: Apple, like I said, for instance, launched Apple Music to compete with Spotify without completely upending its ecosystem.
• 16:12
  SPEAKER_00: And to be fair, it probably enhanced its ecosystem as well.
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  SPEAKER_00: Other examples could be Warby Parker counterpositioning vs.
• 16:21
  SPEAKER_00: Esslor Luxotica with cheaper glasses, mostly focused online.
• 16:25
  SPEAKER_00: While I don't think it's really working just yet, it is a counterpositioning strategy.
• 16:30
  SPEAKER_00: Tesla, of course, by bypassing traditional dealership models with director consumers, and like I said, Netflix vs.
• 16:38
  SPEAKER_00: Blockbuster back in the day.
• 16:41
  SPEAKER_00: These are some quick examples of counterpositioning.
• 16:45
  SPEAKER_00: Now I do believe there is one more mode, but it's not really in any of the books, and I like to call it ecosystems.
• 16:53
  SPEAKER_00: Companies like Apple and Google are great examples.
• 16:57
  SPEAKER_00: Apple's ecosystem isn't just about the iPhone, it's about the seamless integration between iPhones, MacBooks, Apple Watches, and services like iCloud and Apple Music.
• 17:10
  SPEAKER_00: The more products you own, the harder it is to leave.
• 17:15
  SPEAKER_00: The same goes for Google, which combines Android, YouTube, Google Search and Gmail into one sticky ecosystem.
• 17:24
  SPEAKER_00: The ecosystems drive customer loyalty, recurring revenue, and enormous profits.
• 17:32
  SPEAKER_00: Which it's all about for most companies, right?
• 17:35
  SPEAKER_00: An ecosystem can allow other modes to thrive.
• 17:39
  SPEAKER_00: Think switching costs, network effects, or economies of scale.
• 17:44
  SPEAKER_00: This one can be exceptionally powerful if obtained.
• 17:48
  SPEAKER_00: However, it's actually pretty easy to spot, since the companies are already so large usually.
• 17:55
  SPEAKER_00: But if you can spot this in the early days, if you could spot an early Apple, Google, Adobe, Tencent, Amazon or even Meta, you would be well rewarded for it.
• 18:06
  SPEAKER_00: And I do think there are new companies out there with this mode, or at least trying to build this mode.
• 18:13
  SPEAKER_00: So it might pay off to watch out for this specific mode, if we may call it that.
• 18:19
  SPEAKER_00: So how do you actually spot companies with white modes?
• 18:22
  SPEAKER_00: There are a few signals, and I'll keep this one short and sweet.
• 18:26
  SPEAKER_00: First, check their earnings and cash flow during economic downturns.
• 18:31
  SPEAKER_00: If a company can weather a storm and still deliver strong results, chances are they have some kind of unique advantage.
• 18:39
  SPEAKER_00: Coca-Cola, for instance, even in recessions, people tend to still buy their products.
• 18:45
  SPEAKER_00: Pay attention to return on invested capital.
• 18:48
  SPEAKER_00: High-end growing ROIC is a great indicator of a mode.
• 18:52
  SPEAKER_00: It shows that a company can deploy capital effectively, efficiently, and still earn strong returns over time.
• 19:00
  SPEAKER_00: For example, luxury companies like Hermes and Ferrari consistently deliver high ROIC because of their strong pricing power and customer loyalty.
• 19:11
  SPEAKER_00: Just keep in mind that ROIC can sometimes be skewed by accounting practices, so what you see is not always what might be the case.
• 19:19
  SPEAKER_00: Don't forget about revenue and profit margins, obviously.
• 19:23
  SPEAKER_00: Compare them to competitors.
• 19:24
  SPEAKER_00: If a company consistently outperforms its peers, there is a potential sign of a moat.
• 19:31
  SPEAKER_00: And of course, barriers to entry.
• 19:33
  SPEAKER_00: How easy is it for new competitors to replicate the business?
• 19:37
  SPEAKER_00: For ASML, the answer is nearly impossible, but not every company is ASML.
• 19:44
  SPEAKER_00: So how hard would it be for someone else to enter?
• 19:47
  SPEAKER_00: Something to think about.
• 19:48
  SPEAKER_00: And there is a fun thing to look for sometimes.
• 19:51
  SPEAKER_00: Competition can sometimes strengthen a mode.
• 19:54
  SPEAKER_00: Think Monster and Red Bull, Pepsi and Coke, or Visa and MasterCard.
• 20:00
  SPEAKER_00: They have all created a duopoly in a way, and their rivalry keeps them sharp, while new entrants struggle to carve out just a little bit of market share.
• 20:12
  SPEAKER_00: Alright, so why do modes matter?
• 20:15
  SPEAKER_00: They are the ultimate predictor of long-term business success.
• 20:19
  SPEAKER_00: Companies with strong modes generate consistent profits, can weather downturns, and fend off competition.
• 20:28
  SPEAKER_00: And for you and me and investors, finding a company with a wide, durable mode is like finding a fortress, and it protects your capital and it allows it to grow over time.
• 20:41
  SPEAKER_00: At least, that's what we hope.
• 20:44
  SPEAKER_00: Because remember, not all modes last forever.
• 20:47
  SPEAKER_00: Companies need to reinvest in their advantages to keep competition at bay.
• 20:53
  SPEAKER_00: And as Warren Buffett always said, every day your mode is either widening or narrowing.
• 21:00
  SPEAKER_00: Thanks for tuning in to the Dutch investors.
• 21:02
  SPEAKER_00: Until next time, stay curious, keep learning, and happy investing.