Intangible Asset Analysis: Misunderstanding Moat

A good product doesn’t always come with durable economic advantages. Sony makes high-quality DVDs, but you can replace them with Verbatim without much issue. Investingdeck.com tries to resolve one of the misunderstandings about the economic moat. Welcome to our intangible asset analysis.

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“Not looks strong, but actually being strong” | Chris Herria

Too Long, Didn’t Read

When Best is Not Enough.

Morningstar postulates the characteristics of the economic moat as follows: intangible assets, switching cost, economies of scale, and network effect. With regard to an intangible asset, investors mistakenly think it is simply a good, well-known brand with a long history of reputation.

Well, it doesn’t.

BMW has a long reputation for its comfortable car – but it doesn’t mean that this reputation constitutes an economic moat. Another carmaker like Honda or Volkswagen could manufacture the same features with the same level of comfort.

The reason behind this misunderstanding is people tend to trust something familiar to them. Thus, a product that is associated with a brand, like Ford for car or Coca-Cola for a soft drink is much acceptable from investor perspectives.

Consider this, if all investor has same familiarity – where is your edge?

The Past Perfect

In many cases, relying too much on reputation kill a company’s future. It kills innovation, development, and bring complacency comes. Remember Nokia, once it dominated the phone market but was then killed by Samsung and Apple. Because it stubbornly adopts Symbian when Android comes and offers many features. Being the largest phone manufacturer doesn’t help. Your past doesn’t guarantee your future. Another example is Xerox. Xerox is a copy machine and a copy machine is Xerox, till cheaper competitors come.

This is why it is always day 1 on Amazon. The day that you are enthusiastic about your job, about serving customers, about delivering the best. Bezos doesn’t want his team to comply.

If great managers avoid being complacent about reputation, why do investors take decisions solely on it?

Intangible Asset Analysis: Good Product Sometimes Doesn’t Stand Against Brutal Competition.

Another proof that reputation is fragile is in the fast-food industry. Form outside, every big player seems strong. MacDonald, KFC, Burger King, Taco Bell – all have a strong brand presence. But none has a robust economic moat. Buying one product doesn’t prevent sales of the other. Someone can buy a bacon cheeseburger today and get lunch in KFC tomorrow. Every player has an alternative. The competition is wide open.

In this kind of industry, room for error is minuscule. Delivering bad taste or items will be punished by people since it is easier to pick the competitors.

This is not suitable with the economic moat concept that makes the competitor is far away from markets share.

Intel and AMD in Intangible Asset Analysis: Emulating Zero-Sum Game.

It is almost unlikely you will use both processors even you have two computing devices. Someone may be a fan of a specific processor, whether it is Intel or AMD.

Unlike ice cream, pizzas, burgers, or other fast food, we limit the number of computing units we have. Too many computers won’t be efficient. Thus, creating some degree of competitive advantage for processors makers like Intel and AMD.

This circumstance doesn’t favor computer makers like HP, Dell, Lenovo, Asus, Acer, MSI. For daily use in the office, we may take Lenovo, but we have Dell PC at the home for WFH.

On some level – not perfect – the rise of AMD will eclipse others, and vise versa. We see a certain degree of economic moat here.

Netflix and Disney Fight to Take Customer Time

At a glance, the Streaming business mimics a zero-sum game environment. Though you can subscribe to more than just one streaming service, in the end, you may realize that you only need one. Or two at most. It is because you are very busy and have only 24 hours. A third of them are for work, the other third for sleep. How much is left for you to take “me time” watching movies on your devices? Not much.

Thus, only a few franchises you are willing to watch on your devices or smart TV. It sounds like bringing the competitor at bay. True, but if we consider the other group of industries that can fit your spare time, these advantages start to look elusive.

Outside streaming groups like Disney+, Netflix, Paramount, people can play their game on console, Wii, PS5, Xbox, or even free services like YouTube.

So, no, we don’t see any intangible assets as economic advantages in the streaming business. Reputation doesn’t do magic here, like in the fast-food industry.

Perfect Example: Office 365

Office 365 is on another level. Whether you purchase or subscribe to these Microsoft productivity tools, it is almost impossible for you to use the competitor’s product. In this case, we have a perfect condition of using one product straightforwardly eliminates the others. Another good example is Windows OS which almost nullifies competitors’ efforts to gain market share.

But, to be honest, it is not a reputation that builds Microsoft and its Office economic moat. It is the network effect that causes it. Brand reputation only helps Microsoft build the network effect at the early phase of its OS and productivity tools.

This characteristic is something that the fast-food industry or streaming services don’t have.

Another example of great reputation incorporated with another business advantage is Adobe and AUTOCAD. Both have legendary reputations in their respective field – in graphic design and in engineering. The use of Adobe or AutoCAD extends competitors at bay.

German Software.

Then we have SAP. The Germany-made software is far from customer satisfaction. SAP is well known for its complex and poor UI – but it doesn’t prevent customers to keep sticking with it. The enterprise resource planning software is the perfect antithesis. A bad reputation, somehow, could constitute durable competitive advantages.

And as readers expect, it doesn’t come from reputation. It comes from the switching cost like Office 365.

Final Thought on Intangible Asset Analysis

We firmly believe that readers now can distinguish between brand reputation and economic moat. As we stated earlier, a good product doesn’t necessarily have a competitive advantage.

We suggest readers visit more about intangible here:

https://investingdeck.com/intangible-as-a-lasting-competitive-advantage/