Saturday, May 5, 2012

The Little Book That Builds Wealth: Chapter 6

Morningstar's equity research director authored this book on identifying companies with competitive advantages. Dorsey separates competitive advantages into four categories, providing a framework for understanding how wide a moat a company really has. The book is full of examples of companies Dorsey believes have moats, and the reasons why their moats are likely to last - or not!

Cost advantages are explored in this chapter. Cost advantages can come from cheaper processes, better locations, unique assets and greater scale. The next chapter is devoted to the important scale advantage, while this chapter focuses on the first three cost cost advantages.

In theory, process advantages shouldn't exist for long, as competition should figure out ways to copy incumbents. But in practice these advantages can last a long time. Dell (with PCs) and Southwest Airlines are examined to understand why competition was unable to replicate their efficient processes for many years.

Location-based advantages are more durable than process-based ones because locations are much more difficult to duplicate. This can occur frequently in commodity-based businesses, where transportation costs are high relative to product costs.

Finally, unique assets are a catch-all category. An example of a unique asset providing a cost advantage is an easy-to-extract-from (relative to the competition) oil resource.

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