Why I Invest In Companies With Intangible Competitive Advantages
In the world of finance, money flows to wherever it can grow the easiest. That’s why great business ideas are quickly imitated by rival business owners.
I mean… why wouldn’t other organizations copy their competitors? As they say, “You don’t have to reinvent the wheel.”
Good Things Don’t Last Forever
A good idea is hard to protect. Naturally, that makes good profits equally tough to defend. This brings me to the central theme of this article.
The most successful businesses in the world aren’t the ones with the best products or the best leaders. Actually, the best businesses are the ones that have a competitive advantage. Something that helps them attract and retain customers, while also giving them the ability to charge top dollar.
As an investor, I’m always on the lookout for businesses that have a durable competitive advantage because those businesses are most likely to be successful for a long time.
Here is a list of 4 intangible competitive advantages that I look for in a company before I invest.
Intellectual Property: The Intangible Moats That Protect Profit
Brand Power
Iconic brands become household names by developing and reinforcing a strong reputation. The most powerful brands need not be explained because their name is synonymous with their marquee product. This is a level of brand notoriety that’s not easily created, nor easily destroyed.
You would be hard-pressed to find someone who hasn’t heard of these products/brands;
Kleenex (Facial tissue)
Jordans (Basketball shoes)
Raybans (Sunglasses)
Windex (Glass cleaner)
Ferrari (Sports car)
Rolex (Watch)
An Über (Ride-sharing car service)
A true economic moat protects the profitability of a business. These brands qualify as such because customers will generally pay more money for a product if it bears one of these trademarks, even if a competitor offers a similar option for a lower cost.
The strongest brands own a small piece of real estate at the top of their customer’s minds.
However, not every brand is a competitive advantage.
Brand power is most evident in industries where quality, performance, and social status are at a premium.
On the other hand, companies that offer undifferentiated products (i.e.: gas stations) cannot leverage brand power to the same extent because their customers can get the exact same gas on every other corner in the city.
Patents
Legally prevent your competition from replicating your product is an unquestionable advantage.
Patents are common in almost every industry, but they are especially critical in manufacturing, medicine, and technology.
By definition, a patent designates the ownership & usage authority for a specific physical good, product, or tangible creation.
If you create a new product that has never been seen before you will want to protect it with a patent so that you have a fair chance to profit from your great idea.
Patents don’t last forever though.
Eventually, they expire and the free market processes take over. This is good for consumers because new, low-cost alternatives are created when patents expire. On the other hand, this is bad for the original creators who may struggle to come up with the next big thing.
A single patented product is a very narrow moat which competitors can cross over given enough time.
A true competitive advantage is the ability to consistently generate new ideas worthy of being granted a patent. The organizations who achieve this are in a league of their own.
Perhaps the best example of this is manufacturing behemoth 3M.
As of 2019, 3M had been granted over 118,000 patents.
That type of creative engineering is an impenetrable moat that the majority of competitors simply cannot replicate.
As of this writing, 3M (ticker symbol: MMM) is a $179 stock that pumps out $9.25 in earnings per share. More importantly, MMM has a plush dividend of $5.92, the equivalent of a 3.34% yield.
No wonder MMM is a core holding in so many dividend focussed portfolios.
Regulatory Approval
It’s hard to get things done when the government won’t let you.
That’s why regulatory approval is a massive competitive advantage.
Regulatory approval is critical when dealing with;
Real estate zoning by-laws
Infrastructure construction projects
Clinical trials of new medicines
Mining for natural resources
… and the list goes on!
Regulatory approvals are most advantageous where industry regulations are most strict, making it tough for new players to enter the market.
A great example of this is the energy sector.
I, personally, can’t just decide to start a utility company. It’s more complicated than that. Outside of the insurmountable start-up costs that come with providing power or natural gas to 100’s of 1,000’s of homes, I would need clearance from local, provincial, and federal regulators to get in the game.
If you‘be ever moved houses you probably noticed that you usually only get 1 electric company and 1 heating & gas company to pick from in your new area.
That is by design.
It simply isn’t worth it for new businesses to pay the cost associated with getting approvals & building out the infrastructure to transport the energy from their facility to your house. It would take too long to setup and they would bleed too much money along the way.
So, utility companies, by default, have legal regional monopolies. This is a major competitive advantage.
A Deep Catalog Of Original Content
The modern consumer wants one thing above all else - Choices. Companies who understand and cater to this demand set themselves apart from the crowd.
“Content” is a catch-all for anything media related.
Generally, media companies source content from 3rd parties, or if they are capable, they produce new content in house…
Original content is where the real money is.
Here are some traditional and emerging industries that rely on a steady flow of new content:
Newspapers, Magazines & Blogs = Written Articles
Podcast Networks = Audio Conversations
Music Streaming Platforms = Songs
At-Home Entertainment = Movies & TV Shows
Home Fitness = Live & Recorded Workouts
Online Education = Live & Recorded Lessons
Meal Kit Delivery = Dinner Recipes
Online Gaming = Games & Feature Updates
Businesses that can produce the highest volume of the best content are able to attract more subscribers who stay around paying higher prices for longer periods of time.
Evidence of this theory is clear when we look at Netflix.
In January 2021, Netflix shares jumped on news that they had “added 8.5 million users in Q4—40% above its estimate—to close the year with 204 million subscribers.”
This is because investors realize that without subscribers, Netflix doesn’t make money. So, anything that will attract & retain subscribers longer is a competitive advantage.
The ability to produce great content at a fast pace is difficult to replicate and therefore qualifies as a competitive advantage.
What Does This Mean For Your Business As An Entrepreneur?
If you want to increase your profit margins and be able to command a higher price in your market, you need to identify and fortify your moat.
Breakdown Your Business Model
Are you a luxury brand? Then you need to establish authority by creating an air of prestige in everything you do.
Are you a manufacturer? Seek to identify product gaps in the current market landscape that you serve. Be first to move and put your flag in the ground.
Are you a social media influencer? Then your focus should be on creating the highest volume or value-packed content possible. Flood the market with your best thoughts and hot takes.
Invest Like An Owner
Hopefully, this article has given you new perspective on the intangible factors that play into corporate success.
Now, equipped with these idea, I want you to look critically at the investments you hold in your portfolio and ask yourself - What is the competitive advantage here?
Not every business leverages intellectual property as a competitive advantage, but those who do are hard to beat.
Whats’s in your portfolio? Leave a comment and let me know.