The most important thing to me is figuring out how big a moat there is around the business. What I love, of course, is a big castle and a big moat with piranhas and crocodiles. ?Warren Buffett

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Measuring the Moat: Assessing the Magnitude and Sustainability of Value Creation

Below is an excerpt of “a complete checklist of questions to guide the strategic analysis” published in the paper Measuring the Moat: Assessing the Magnitude and Sustainability of Value Creation, written by Michael J. Mauboussin and Dan Callahan.

Measuring The Moat Value Creation Checklist

Value Creation Checklist

  • What stage of the competitive life cycle is the company in?
  • Is the company currently earning a return above its cost of capital?
  • Are returns on capital increasing, decreasing, or stable? Why?
  • What is the trend in the company’s investment spending?

Lay of the Land

  • What percentage of the industry does each player represent?
  • What is each player’s level of profitability?
  • What have the historical trends in market share been?
  • How stable is the industry?
    • How stable is market share?
    • What do pricing trends look like?
  • What class does the industry fall into—fragmented, emerging, mature, declining, international, network, or hypercompetitive?

The First Three of the Five Forces

  • How much leverage do suppliers have?
  • Can companies pass supplier increases to customers?
  • Are there substitute products available?
  • Are there switching costs?
  • How much leverage do buyers have?
  • How informed are the buyers?

Barriers to Entry

  • What are the entry and exit rates like in the industry?
  • What are the anticipated reactions of incumbents to new entrants?
  • What is the reputation of incumbents?
  • What is the level of asset specificity?
  • What is the minimum efficient production scale?
  • Is there excess capacity in the industry?
  • Is there a way to differentiate the product?
  • What is the anticipated payoff for a new entrant?
  • Do incumbents have precommitment contracts?
  • Do incumbents have licenses or patents?
  • Are there learning curve benefits in the industry?

Rivalry

  • Is there pricing coordination?
  • What is the industry concentration?
  • What is the size distribution of firms?
  • How similar are the firms in incentives, corporate philosophy, and ownership structure?
  • Is there demand variability?
  • Are there high fixed costs?
  • Is the industry growing?

Disruption and Disintegration

  • Is the industry vulnerable to disruptive innovation?
  • Do new innovations foster product improvements?
  • Is the innovation progressing faster than the market’s needs?
    • Have established players passed the performance threshold?
    • Is the industry organized vertically, or has there been a shift to horizontal markets?

Firm Specific

  • Does analysis of the value chain reveal what activities a company does differently than its its rivals?
  • Does the firm have production advantages?
    • Is there instability in the business structure?
    • Is there complexity requiring know-how or coordination capabilities?
    • How quickly are the process costs changing?
  • Does the firm have any patents, copyrights, trademarks, etc.?
  • Are there economies of scale?
    • What does the firm’s distribution scale look like?
    • Are assets and revenue clustered geographically?
    • Are there purchasing advantages with size?
    • Are there economies of scope?
    • Are there diverse research profiles?
  • Are there consumer advantages?
    • Is there habit or horizontal differentiation?
    • Do people prefer the product to competing products?
    • Are there lots of product attributes that customers weigh?
    • Can customers only assess the product through trial?
    • Is there customer lock-in? Are there high switching costs?
  • Is the network radial or interactive?
  • What is the source and longevity of added value?
  • Are there external sources of added value (subsidies, tariffs, quotas, and competitive or environmental regulations)?

Firm Interaction - Competition and Coordination

  • Does the industry include complementors?
  • Is the value of the pie growing because of companies that are not competitors? Or, are new companies taking share from a pie with fixed value?

Brands

  • Do customers want to “hire” the brand for the job to be done?
  • Does the brand increase willingness to pay?
  • Do customers have an emotional connection to the brand?
  • Do customers trust the product because of the name?
  • Does the brand imply social status?
  • Can you reduce supplier operating cost with your name?

Measuring The Moat Value Creation Checklist 2

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Article by Hurricane Capital, Old School Value