The Little Book That Builds Wealth - Chapter2

In this chapter Pat explains how it is important for us not to understand the factors that create a moat for a business.  Some companies may be performing good in a tough industry and be better than others. But that does not make them stalwarts and create competitive advantage.  It is always better to have an average company in a great industry  than one that is the number in a tough industry.  Even though companies in  tough business may perform great in short term, in long term others will catch up and bring their profitability down.
Size does not matter.  It could be a small cap company that has virtually no competitors or it could be a very big company but with no pricing power.  In India when Bharti Airtel started even though it was a small company, it had virtually no competitors and it had good pricing power.  Compare that to the Bharti Airtel today.  There are too many players now and everyone is trying to drive down the prices so much that  there is hardly any profitability.  There is no pricing power for Airtel.  There is no differentiation in perceived quality for the customer if they move from Airtel to say Vodafone. If they increase price, customer will switch.

So, great products, great size, great execution or great management does not create a competitive advantage. Then what should we look for to identify companies with great competitive advantage?  As per Pat, they are

• Intangible assets like brands, license, patents etc. which keeps the competitor from copying. Some examples of brand are Maggie, Nescafe etc.  Coal India with mining license is a good example.  
• High switching cost.  It is difficult for the customer to switch to a different product.   Eg. Microsoft.  If company has to think of changing its operating systems or office products, it is very difficult to do as they have to train everyone and also worry about their compatibility with other companies in the business world with which it interacts
• Network effect -  Most recent example of this is Facebook.  Why is Facebook more popular than google+.  The answer is because 'Its popular'.  If all your friends and relatives are already in Facebook, why would you open your account in google+.  Also, if you already have Facebook where all your friends and relatives are there, would you create another account in google+ and maintain both?
•  Cost advantage - Company has some structural cost advantage because of which it provides products or services at a cheaper cost than any competitor.