What are competitive advantages and why are they important?

A company has a competitive advantage when they do something better than other companies in the same industry and this results in higher profitability

A competitive advantage can be temporary. Maybe such an advantage only lasts for 1-2 years, before the competitors catch up. For a competitive advantage to be lasting, something more is required. As the Chinese-American value investor Li Lu said:

“Successful businesses have some combination of things that enable them to adapt to changes better than anyone else. In each situation, it’s slightly different.”

The most common competitive advantages are: Differentiated product, well-known brand, cheapest manufacturer in the industry (lowest costs), high switching costs, and monopoly via legislation.

Sustainable competitive advantage

A competitive advantage rarely lasts more than a few years before it is copied by competitors or otherwise disappears. A competitive advantage is said to be permanent or sustainable if it persists over longer periods of time (5-10 years or more). At best, the competitive advantage becomes stronger and stronger every year, until the company achieves a monopoly.

Competitive advantage vs. business model

A company can have a competitive advantage because they have a new or different business model than other companies in the same industry. But it is unusual. It is more common for several companies within an industry to have the same or similar business models, but one of the companies is better than the others at execution.

14 important sources of sustainable competitive advantages (moats)

1. Legislation

2. Geographical location

3. First-mover advantage

4. Network effects

5. Local monopolies

6. Brand

7. Low-cost producer & economies of scale

8. Capital structure: access to cheap capital

9. Minimum number of employees, high profit per employee

10. Sales force

11. Good Management

12. Proprietary Technology & Trade Secrets

13. Customer Loyalty, Lock-in and Switching Costs

14. Marketing Advantages

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In the Investing Course we will teach you about these competitive advantages in detail. And when they may or may not apply, and whether they can be sustainable or not. This is an important part of business analysis. But to be honest, it’s less important than valuation, stock selection and building a watchlist.

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