A Fool looks at crony capitalism and geographic moats.
Even the strongest business needs to watch out for someone who comes along with a better product. One way to deter your competitors from doing this is to make it harder for them to compete in your markets.
Some companies do this by resorting to 'crony capitalism', where they lobby politicians to pass laws that favour their businesses by restricting competition. This is usually dressed up with excuses like 'saving jobs', reducing the country's dependence upon imports or by introducing dubious health and safety concerns. In any event, crony capitalism allows the beneficiaries to earn abnormally large profits at the consumer's expense.
Many companies can't engage in crony capitalism, either because it is too expensive or too impractical. But one way in which they can still limit the ability of others to compete with them is to create what Warren Buffett calls a "moat" -- things such as brands, economies of scale, trademarks or a corporate culture that can't easily be copied.
The tyranny of distance
Another kind of moat is that created by geography. A geographic moat exists when it is much more expensive for your competitors to deliver their goods or services to customers in the region that you serve. If strong enough, it can even create a local monopoly.
The textbook geographic moat is that possessed by a gravel pit. Gravel is a cheap product, which is very expensive to transport long distances because of its weight. So it is very difficult for gravel pits in other regions to compete with a local gravel pit, because the further the gravel has to be moved, the less profit can be made.
As a result, people tend to buy gravel from the nearest supplier. While this moat lets a gravel pit owner charge fairly high prices, they can't charge too much because at some point it will become cheaper to buy gravel from elsewhere and pay the extra haulage cost.
Another geographic moat is to have a business that can't easily be outsourced to another country with cheaper labour costs. A good example is the textile services company Berendsen (LSE: BRSN), which I looked at two weeks ago, which has a substantial laundry business.
Laundry is something that tends to be done locally because of the high cost of moving it relative to the cost of the work. While laundry can be done more cheaply in China, not only does it cost a lot to ship it there but this would add several weeks to the turnaround time. So your customers would have to buy more textiles than if the laundry was done locally in order to cover for those that are being cleaned in China.
However, it may be cheaper for a business to move its customers' laundry some distance to a regional centre, which will then create economies of scale because of the very large amount of laundry that will be processed in these locations.
Many service businesses are impossible to offshore. But they can still take advantage of the free movement of labour by importing workers from lower-wage countries and, in these cases, the geographic moat protects the business but not its staff.
Telecommunications trumps geography
Until the early 1980s, British commercial television had a fantastic geographic moat because each broadcaster had a legally defined geographical region in which only they could broadcast.
But the creation of Channel 4 -- followed soon afterwards by cable and satellite broadcasting -- destroyed this moat. New technology and deregulation eliminated local TV companies' highly profitable monopolies, causing their profits to tumble. Eventually, they had to merge into one company, ITV (LSE: ITV), in order to reduce their costs.
Transportation also trumps geography
Back in the days before telephones and motorised transport, most businesses had a strong geographic moat. If you were the only pub, shop or blacksmith in a town, then the locals had a strong incentive to deal with you.
Cars, cheap public transport and telecommunications breached most of those moats, and a similar scenario is currently being played out in the developing world thanks to the rapid spread of mobile telephones.
Mobile phones are creating an economic boom in parts of Africa because producers and consumers can use them to get up-to-date information about prices and products. For example, African fishermen used to have to take pot luck when deciding where to land their catches, but nowadays they can phone several ports while they are returning from a trip and find out which one is offering the best prices.
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> Tony does not own any share mentioned in this article.