The topic of economic moat is often discussed, but perhaps less well understood. In order to appreciate how a better understanding of a company’s moat can help us become better investors, I spoke with Matthias Riechert, a value investor in the tradition of Columbia Business School. Matthias Riechert is co-founder and portfolio manager at Polleit & Riechert Investment Management based in London. Polleit & Riechert’s goal is to significantly increase client wealth – adjusted for inflation. Starting with the premise that pervasive government interventions will increasingly impact market outcomes, Polleit & Riechert have focused their investment approach on great investments for times of inflation. The concept of moat, and investing in attractively-priced wide-moat businesses, is an essential ingredient of that approach. I’m pleased to share from my conversation with Matthias Riechert the below excerpt on the supply and demand perspective of a company’s moat. The full interview with Matthias Riechert is available in The Manual of Ideas Members Area.
The Supply and Demand Sources of Moat
Says Matthias Riechert:
“So, simply put, we are looking for companies that can do something that others can’t, and ideally over the long run. So the advantage, whatever it is, should be durable. And then very quickly you end up looking for specific barriers to entry. And this is what we call the Greenwaldian theory that was brought out very nicely by Professor Bruce Greenwald at Columbia Business School.
And so what he does is, he looks at companies and really looks first of all at competitive advantages on the demand side. So what causes consumers to pay more for a good that others could theoretically produce in a similar way? The best example of course is Coca-Cola [KO] that Warren Buffett always comes up with but there are many, many other examples. And there are basically only three barriers to entry on that side.
And those are switching costs, very interesting to look at. So, companies like Novo Nordisk [NVO] are having really high switching costs. So Novo Nordisk produces insulin and as a diabetic you need to do a lot of training together with your doctor to get comfortable with the amount of units you need of insulin. So if somebody else would come up with a cheaper, similar insulin, you wouldn’t switch that easily because, again, there’s a lot of training and also risk involved. So the switching costs are very, very high.
The other part is consumer habits, like drinking a Diet Coke every day. That’s a typical habit. And you could have a third one which is search costs. And search cost is something that for example McDonald’s [MCD] has. So if you travel and you go somewhere else, you’re hungry and you see the big “M” sign, you know what you get. Whether it’s good or not, I leave that aside. But at least you know what you get. And that’s very valuable. And those are the three on the demand side.
And then you’ve got others on the supply side, which basically means companies are able to produce something at a cheaper cost than others can. And there are several ways you could look at it. There are some technological examples, ideally protected by patents. Then you have the economies of scale. So you can spread fixed cost and you have network economies where you become more attractive, the more people use your product, and some others. So, there are really some qualitative and quantitative ways to search for those companies.”
Matthias Riechert is one of the instructors at Wide-Moat Investing Summit 2013 on July 9-10.