The term “economic moat” describes a company’s ability to maintain its competitive advantages and defend its long-term profitability. This moat investing education series explores the five primary sources of moat, according to Morningstar: 1) switching costs; 2) intangible assets; 3) network effect; 4) cost advantage; 5) efficient scale. Here we explore the concept of intangible assets.
Intangible Assets Help Build Strong, Identifiable Advantages
Patents are a legal barrier to entry that protect companies from unauthorized commercial usage of their products by competitors. Similarly, government licenses may raise the entry hurdles for new competitors. Additionally, brands equity can increase a customer’s willingness to pay for a product or service. These are examples of what Morningstar refers to as “intangible assets.”
Intangible Assets. Patents, brands, regulatory licenses, and other intangible assets can prevent competitors from duplicating a company's products, or can allow the company to charge a significant price premium.
Although not always easy to quantify, intangible assets are one of the primary sources of strong competitive advantages for businesses and a key economic moat source. Intangible assets can include corporate intellectual property, such as patents, trademarks, copyrights, government licenses, and business methodologies that help companies generate economic profits.
Intangible Assets in Action
Starbucks Corp. (SBUX) is the leading specialty coffee retailer in the U.S. According to Morningstar, Starbucks’ wide economic moat comes from its “brand intangible asset that commands premium pricing combined with meaningful scale advantages.” Morningstar adds, “With a widely recognized brand, Starbucks is among the few retail concepts to be successfully replicated across the globe.”
Eli Lilly and Co. (LLY) is a pharmaceutical company that focuses on neuroscience, endocrinology, oncology and immunology. Patents are critical in preventing competitors from duplicating its drugs. Morningstar notes that “patents, economies of scale, and a powerful distribution network support Eli Lilly’s wide moat. Lilly’s patent-protected drugs carry strong pricing power, which enables the firm to generate returns on invested capital in excess of its cost of capital.”
Company-specific information based on Morningstar analyst notes last updated as follows: Starbucks Corp.: 3/19/2020; Eli Lilly and Co.: 12/6/2019.
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