December 2019 – Understanding a “Network” Moat
As mentioned in November’s memo an Economic Moat is defined as something intrinsic, embedded in a business that allows it to charge higher than normal rates over a sustained period which somehow protect it from competitive forces. This Moat is the theoretical barrier between the underlying business and its competition. The wider the Moat, the greater the chance the business has at protecting itself when being attacked by new and existing competitors.
Last month I discussed the Switching Cost Moat where the tangible and intangible (psychological) costs of switching away from one supplier (of a good or service) to another is very difficult. This month I will discuss another elusive Moat that not many people think about; the “Network” Moat.
I touched briefly on this type of Moat in Episode 16 of the Value Stock Podcast in my analysis of Richie Bros Auctioneers (NYSE: RBA) where their business is fundamentally dependent on having a large network of buyers and sellers. Richie Bros business could not be successful if it only had willing buyers and a minimal number of sellers of equipment. Why would buyers show up if there were no sellers? Would any sellers show up if there were no buyers?
Another instance of a Network Moat is FedEx (NYSE: FDX) or UPS (NYSE: UPS). In order for customers to be attracted to use their services they have to have as wide an offering of shipping origin/destinations as possible. Can you imagine being a courier service provider with the slogan “We ship anywhere…except…”? People use FedEx because they know their item can get anywhere in the world in a relatively quick manner. To manage that many assets, partners and 3rd party suppliers in order to offer such an expansive service offering is considerable because most of the traffic is not going to the middle of Lithuania. Most of the traffic is very concentrated because the world’s population is very concentrated. Regardless, FedEx must provide service on as many routes as possible because their customers expect and want that.
Facebook (NASDAQ: FB) has a network Moat where the business model is dependent on the number of users that use their service in order to appeal to advertisers. However, the number of users that use Facebook’s service is dependent on the size of the overall network. If 75% of your contacts (i.e. “Friends) left Facebook tomorrow, would you find it to be a very valuable social media tool? The real value in a social media network is being able to look up to see what your friends are up to at any given point of the day or having other people see what you are doing at any given point of the day. It is not necessarily the technology that is involved in delivering the service.
Occasionally you will see a lot of companies who are attempting to establish/maintain a network Moat make seemingly bad acquisitions of unprofitable companies. These acquisitions are strategically used to expand their network which increases their overall service offering and value proposition to their customers. FedEx and Richie Bros continually add to their networks by acquiring local companies in areas they don’t already operate. If they don’t make these acquisitions than their Moat may be compromised in the future. If Facebook had not acquired Instagram back in 2012 than their Network Moat could have been severely damaged through the loss of users to a competing platform.
Network Moats can be found in various industries and it can often be strategically found in companies that also have other types of Moats as well. Some other companies to look at with Network Moats are Visa, Mastercard, Alphabet (Google) and eBay.
If you have any suggestions, comments or feedback that you would like to share feel free to email me at alex@StockWriteUps.com.
Enjoy the Journey,