Value Investing Pioneers Summit, Delhi. Session on “MOAT-A four letter word” By Rajeev Thakkar

Contributed By :

Deepak Mundra, CFA and Kanwaljeet Singh, CFA

The Delhi chapter of CFA Society-India had the privilege of hosting some of the most famous pioneers of Value investing in India during its inaugural Value Investing Summit on 21st Sep 2017.

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Mr. Rajeev Thakkar in his session on “MOAT- A four letter word” used a framework provided by Pat Dorsey in his book The Little Book That Builds Wealth to explain how moats are created by companies. He explained how moat provides a competitive advantage to a company as compared to its competitors.

Economic Moat refers to identify companies with durable competitive advantage.

Morning star’s Pat Dorsey, CFA, suggests that there are four kinds of economic moats that we should look for when analyzing businesses:

  1. Intangible Assets- Refers to the Brand power of a Company. The Company’s brand is its ability to lock in the customer permanently as a result of which the customer wouldn’t look any further and thereby reduces the search cost of the customer as well.
  2. Customer Switching Costs-This represents a huge cost to customers when they think of switching a product or a brand and as a result of it the company will command a pricing power from its customer
  3. Cost Advantages- An excellent example in a case would be of “Dollarshaveclub” (Company) which challenged the existing and a marquee player “Gillette” purely based on its low cost shaving blade advantage. The Company’s CEO reminded its customer as to why they need to pay for a fancy handle and endorsement cost of tennis star Roger Federer for the shaving blade that they get for 1$ a month and thereby offering a great competitive cost advantage to the Company.
  4. Efficient Scale (cost economics)-This refers to the similar Moat as discussed above but the one which is purely backed by the scale-based cost advantage to which the customers are going to stick for long.

He then proceeded to take contrarian view using “ABC – Arrogance, Bureaucracy and Complacency” framework as explained by Warrant Buffett in Berkshire Hathaway Report of 2014. Rajeev pointed out that these moats are at risk due to disruption by a new comer, complacency which creeps in due to long period of competitive advantage enjoyed by the company. It results in taking the customer for granted, using an inferior raw material, increasing prices at will etc. all of which in turn may result in losing competitive advantage built by the company. Customers start taking note of these changes and look for alternatives.

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He used following examples to make his point:

Kwality icecream: This company was very famous in the late 1990s and commanded lion’s share of the icecream market in India. After enjoying this leadership position for a long period of time, complacency started creeping in. The company started using the synthetic material in lieu of natural milk product. The Customer took note of it and started deserting company when Amul came with the promise of giving the product which had natural milk ingredients. He mentioned that though sales of Kwality probably kept increasing due to increase in the market as a whole but it slowly started losing its leadership position.

Nespresso of Nestle: Nestle has retained its leadership position in instant coffee market through series of innovation. However, these innovations had cost attached to them but with innovations, the company was able to keep its competitors at bay. One of these innovations was “Nespresso pods” which in a way killed the company’s existing business but the company had a first mover advantage with these pods. However, in last few years, local manufacturer started offering pods at very low prices, challenging the company. If the company doesn’t heed to this challenge, its leadership position is at risk.

HP Printer: HP had a long leadership position in the printer industry. Once a customer had HP printer he became a life-long customer of HP as only the refill provided by HP would work on these printers. The cost of refill by HP was much higher than refill provided by other companies. When HP realized that customers found the loophole to circumvent this by using refill provided other manufacturers, it started putting sensors so that customers cannot use refill provided by other companies and the company will get to know if used. It gave an opportunity to company like a EPSON and others to offer printers for which refill cost was much lower than HP.

Suggested reading:

The Little Book that Builds Wealth on value investing by Pat Dorsey

Suggested Videos:

Google talk by Pat Dorsey:

https://www.youtube.com/watch?v=YFS5JBgz1Xc

The Capacity to suffer by Thomas Russo

https://www.youtube.com/watch?v=GSNBTaPYAng&t=51s

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