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Signs Of Businesses With Sustainable Competitive Advantages

Monday 04, 11 2019
One of the important principles set out by Warrant Buffet that makes him successful when investing is to invest in businesses with sustainable competitive advantages. In his bestselling book many years ago, Phil Town's also mentioned competitive advantage a lot because he considered it a stronghold to prevent the “invasion” of other businesses and to create outstanding business results as well as opportunities for long-term profitability. So how can a business with sustainable competitive advantage be recognized? Through research, sustainable competitive advantage is identified based on qualitative and quantitative perspectives.
Signs Of Businesses With Sustainable Competitive Advantages

A. Qualitative perspective 

1. Valuable intangible assets

Intangible assets, including trademarks, patents, or government licenses, are imprinted on the consumers’ mind, affirming the reputation of the business and contributing to reducing competitiveness of competitors, especially in industries where barriers to entry are strictly regulated.

Eg.: StarBucks’ drinks can be sold at prices which are 25%-35% higher than other competitors’ in Vietnam; prestigious fashion and watch brands as well as luxury car manufacturers are always welcome by buyers even though their prices are very expensive, etc .;

2. Low cost

Companies with the ability to provide lower cost goods and services have a great advantage because they can “knock-out” their rivals with selling prices. On the other hand, they can sell their products or services at prices comparable to competitors, but achieve higher profit margins. The advantage of large scale is the typical low-cost advantage.

Eg.: HPG has a large production scale and modern technology with the ability to implement projects quickly and economically, so the cost of goods is 12% lower than other companies in the same industry in Vietnam. In the 2016-2018 period, HPG's gross profit margin was 20-24%, while its competitor’s margins hover around 8-12%. VNM’s gross profit margin is very high, at 45% thanks to low production costs when modernizing technology and enlarging production scale, while that of its competitors are less than 25%. MWG has a higher profit margin than other competitors due to the fact that its import volume of goods is dozens of times higher than others. Walmart also imports goods in very large quantities, so the cost of goods is much lower than other competitors in the US.

3. Conversion costs

These are the inconveniences, major risks or costs that customers have to spend once to change from one product to another. Customers who face high conversion costs often don't change suppliers unless new suppliers bring them a much greater and long-term benefit over those conversion costs. 

Eg.: In the software field, if customers want to use a completely different product, they will face the risk of interruption in their system operation while using products of: Oracle, Adobe, Microsoft ...

4. Resonance value

This happens when the value of a particular product or service increases the benefits for both new and existing users when there are multiple users of the goods or services. Multiple utilities within the ecosystem of the businesses often create a visual circle that allows them to get stronger and stronger.

Eg.: When Facebook has more users, the users will be interacting and connecting more, making them more satisfied. On the other hand, Facebook will sell more ads at higher prices. When people buy VinGroup's houses, they tend to use other VinGroup's services such as hospitals, schools, commercial areas, resorts, etc.

5. Effective scale

This happens when businesses must achieve a certain size to be profitable, and when one or a few businesses have already dominated the market physically, there is not much room for new comers.

Typically, in the water supply industry, when businesses have completed the construction of water supply systems for consumers, there will be no opportunities for other suppliers to exploit existing customers. Another example is the railway industry, when the former enterprises have invested in the construction of rails to transport customers and goods, there will be no room for other enterprises to build a similar railway. The same thing happens with the electrical system in Vietnam.

B. Quantitative  

1. Gross profit margin

If this index is high, the enterprise has a special competitive advantage, because most businesses only get a high gross profit margin it has one or more of the followings: 
  • Strong influence on customers thus selling at prices higher than competitors; 
  • The ability to negotiate with suppliers, or modern technology to achieve lower costs than competitors. 
In addition, there are businesses that achieve high gross profit margin even though they do not have a competitive advantage because they have special sponsors thanks to the political path or are able to buy low price inputs in a certain period. However, this is clearly not a sustainable competitive advantage.
Signs Of Businesses With Sustainable Competitive Advantages

 2. Return on investment (ROI) and Return on equity (ROE)

The company's sustainable competitive advantage must be effective and only truly enrich the investor when and only when it shows the return on the investment capital or owner's equity at a higher level than usual. Through the study of hundreds of businesses with sustainable advantages, we found that they often have at least 3 times higher ROI and ROE than the bank interest rate in the same period.
 
Above are the criteria that we recommend investors to rely on to find businesses with strong and sustainable competitive advantage. Of course, when investors all find these types of businesses, their prices are no longer cheap and furthermore, the short-term ups and downs of stock prices are sometimes unrelated to their competitive advantage. 
Therefore, we encourage investors to get to know the business through close monitoring by using our company reportsVietnamCredit believes that you can make the right investment decisions when you have the necessary information including development history, shareholder, legal information, financial background… of a certain business.

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