#99 | 4 Invisible Competitive Advantages | Part 2

Most investors chase after what’s visible—the numbers on the chart, the market share, the growth rate. But what if what truly matters is hidden? Secrets that even the wealthiest can’t buy, no matter how deep their pockets. Rare, uncopyable qualities that create impenetrable moats around the business castles of tomorrow.

In part two of our deep dive into competitive advantages, we leave the easily measurable financial metrics behind to explore the four most elusive, bulletproof structures in the business world. These are the invisible forces that deep pockets cannot replicate, concluding with the single most powerful strategy that most analysts miss entirely.

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Transcript

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Picture the richest person you can possibly imagine. Unlimited money, whatever they want. They can write a check for it tomorrow. They can build a bigger factory than anyone else. They can buy a million users overnight with a marketing budget the size of a small country. But there are some modes that even that person cannot buy, not for any price. Because the thing protecting these businesses isn't money. It's time, it's access, and it's deep operational knowledge that took decades to build. You simply cannot copy it with a credit card. Welcome back to the Dutch Investors Podcast. This is part two of our series of the eight types of economic modes. Last episode we covered the four modes you can measure: scale economies, network effects, counterpositioning, and switching costs. Those are the ones that leave a clear, visible trail in the financial numbers usually. Today we are going after the four that are much harder to see and in some cases much harder to break. These are the modes you cannot buy your way into, no matter how deep your pockets are. So let's not get carried away and let's get into the four modes money can't buy. And it's probably the most abused word in all of business. Every single company on earth claims to have a strong brand, but do they? So we need to be strict here. Because, yes, all companies have a brand in a sense, but being recognized is not necessarily a mode. Being well known is not a mode. A logo that people can spot from across the room is not a mode. A real brand mode is one specific thing. It's a customer willingly paying a premium for a product that is basically identical or sometimes even worse than a cheaper alternative, and doing it again and again, year after year. That is the whole test. Can you charge more than a competitor for the exact same utility or product? And will people keep paying it? If the answer is yes, you have a brand mode. If not, you don't really have a branding mode. So the benefit is obvious, you get to charge higher prices for the same stuff. But the barrier is the interesting part. The barrier is the one thing money generally cannot buy. Time. A competitor with unlimited cash can build the same factory and buy the exact same leather. What they cannot buy is 150 years of a brand meaning the exact same thing to the exact same kind of person, without ever changing. You cannot speed that up. You cannot really shortcut it with a massive ad campaign. When a company throws money around trying to force that feeling, customers can smell that and walk away. A good example of this is the French luxury house Hermes. And if you want to prove the mode is real, just look at those margins. Hermes runs an operating margin of around 41%. For comparison, LVMH, the biggest luxury group on the planet, runs around 22%. Caring, the company that owns Gucci, sits around 11%. Hermes earns roughly twice the margin of the single biggest luxury group on the planet, and nearly four times the margin of its most famous rival, while selling, at the end of the day, bags and silk. That gap is the brand mode sitting right there. But here's the part that makes Hermes different. And honestly, that is the whole game. They deliberately make fewer items than people want to buy. On purpose, forever, just like Ferrari. Every single Birkin bag is made start to finish by a single craftsman who trained for years. They only grow production as fast as they can train people, which means they cap their growth at around 6 or 7%, no matter how loud the demand gets. So the real moat isn't the type of leather and it's not really the orange box they sell it in. It's the discipline. It's generations of one family being willing to leave money on the table today to protect tomorrow. Every other luxury house usually gives in. They flood the market and waters the brand down. Over time, they go from ultra luxury to luxury to premium. Hermes won't. Anyone can copy their strategy, but nobody can copy their history or buy their history. Fascinating. That brings us to the next mode, cornered resources. This one is more concrete and it's where a lot of lazy mode claims tend to sneak in. A cornered resource is when a company has special, locked-in access to something its competitors need, but cannot get. That can be a patent, a unique mineral deposit, a government license, or a specific group of irreplaceable people. But there is a test you have to apply as an investor. If you paid full market price for that resource, you don't actually have a mode. You just have a receipt. A gold mine you bought for exactly what the gold is worth is not an advantage. The original seller already pocketed all the value. A real cornered resource is something you got hold of, preferentially or cheaply, that still pays you today and is big enough to explain your high returns all on its own. The example we like to give is ARM. ARM doesn't actually manufacture any physical chips. What they own is the basic intellectual blueprint. Think of it as the foundational language that a company chip speaks. And they license that blueprint to everyone else. Apple, Qualcomm, Nvidia, Samsung, they all build their chips on top of ARM's design. The scale of this is almost unbelievable. ARM-based chips sit inside more than hold your horses 92% of the entire world's smartphones. So why can't a competitor just design their own blueprint and compete? Because anyone can design a blueprint, right? That part is just a few years of engineering. What you cannot copy, however, is everything built around it. Every operating system, every application, and every software tool, already speaking ARM. And millions of software engineers are already trained on it. Switching to a new architecture means throwing all of that collective work away. That is the cornered resource. ARM's gross margins is around 97%, which sounds like a license to print money. But once you subtract the enormous amount of cash they have to pour into research and development just to keep relevant, the real operating margin drops down closer to 20%. The resource is cheap to hand out, but it's not that cheap to keep alive. And remember, owning a great mode and paying a fair price for the company are two entirely different things. ARM is a wonderful business, but whether you are overpaying for it on any given day is a completely separate question. Keep that in mind. Which brings us to the next mode, process power. This next one is maybe the trickiest one to spot. And it's also one people mistakenly slap onto any company that runs well. Let's be precise. Process power is deep accumulated organizational know-how. It's the way a company executes thousands of tiny things across its daily operations that make it structurally cheaper or better than anyone else. The key part is that you cannot copy it by taking the finished product apart. There is no single patent document or no magic machine. There is no single executive who holds the secret. It is spread across thousands of tiny habits and judgment calls built up over decades. Process power only truly exists when your competitor knows exactly what you are doing and still can pull it off. I think a good example is ASML, or a textbook case, TSMC. The Taiwanese company that manufactures the most advanced computer chips in the world makes around 70% of the chips for hire on the entire planet. So why does TSMC stay ahead of giants like Intel or Samsung, even though they can buy the exact same manufacturing machines from ASML? It all comes down to yield. Making a cutting-ash chip takes thousands of individual chemical and physical steps. Yield is simply the percentage of usable chips you get out of each batch versus how many you have to throw in the trash. TSMC's yield on its most advanced chips is, reportedly, over 80%. Samsung, its closest rival, was stuck down around 30 to 40% for a good chunk of last year. That is a massive gap. That is the difference between running a highly profitable business and literally setting billions of dollars on fire. And there's another thing. That gap doesn't live in a machine, you can just go out and buy. The machinery is for sale on the open market from ASML. Anyone with enough money can order one. The gap lives in the collective brains of the engineers, the recipes for running each step, the custom calibration data, and decades of trial and error. Intel and Samsung have thrown tens of billions of dollars at closing this gap and are still behind. Because the one thing none of them can buy at any price is 20 years of slowly, painfully getting better at it. Yes, you can buy the machine, but you can't buy two decades of learning required to make that machine work in the best way possible. That is process power. Which brings us to our final mode, ecosystems. And yes, you could argue this isn't really a separate mode at all, but a combination of the other seven working together, which is fair. But we think it deserves its own name, because something generally different happens at the very top of the business world. An ecosystem mode is when a company stacks several different modes across several different businesses that actively feed each other. The data from business one funds business two. The audience from business two sells to business three. The infrastructure built for business one quietly undercuts every rifle in business four. And at some point it stops looking like a single company with a mode and starts looking like an entire self-sustaining weather system. Let's take a look at Amazon. People often look at Amazon's razor-thin retail margins and say, see, it's a low-quality business if you look at it from a screener, right? They are reading the numbers completely wrong. Amazon retail is really three separate businesses propping each other up. The online stores run at thin margins. Factual, yes. But all the shopping traffic generates a mountain of customer data, and that data feeds an attach an advertising business with massive high margin profits. And the giant infrastructure they built to run that retail store? That became AWS, their cloud business, which now throws off more profit than all of Amazon's retail operations combined. No single mode explains Amazon. The magic is the way the layers feed each other. Another great example outside the West is Tencent. At the very bottom sits WeChat, an app used by over 1.4 billion Chinese people. Essentially every connected person in mainland China uses the app. That is a massive network effect, and it's the foundation. On top of that, they have stacked a gaming business, a digital payments business, and an advertising network. None of those side businesses would be anywhere near their current size without WeChat underneath, driving free traffic. Tencent then takes that massive pool of cash and buys stakes in companies all over the world, which feed content and data right back into the home base. That is why an ecosystem is so incredibly hard to attack. Each individual piece might look beatable if you isolate it. But you are not fighting one business. You are fighting all of them at once, and they are all subsidizing each other. It is no accident that these ecosystems are where the single biggest pulse of stock market value sits today. Alphabet, Microsoft, Amazon, Tencent, just to name a few. So there you have it, all eight competitive advantages. From last episode, economies of scale, network effects, counterpositioning and switching costs, modes you can measure. Today, branding, cornered resources, process power, and ecosystems, modes you can't buy. But before we go, we want to leave you with a useful lesson. Because that is the whole reason we bother looking at businesses so carefully, right? What this list really tells you is something about everything that didn't make it. Most of what people call a competitive advantage, a mode, a slightly better product, a smarter CEO, a great mission, great execution, a nice culture, they're not really modes at all. They are just very good at their job. They help run the business smoothly and great. They can even allow for large margins for a while. But simply being good is temporary, because you can get copied. Those that make the most money will also attract the most eyes every single time. The entire point of this exercise is to force yourself to tell those two things apart. The companies that are merely winning right now, and the rare companies that have a real structural reason why nobody can ever catch them. They are not in the same group. They aren't even close. So the real question to carry out of these episodes is this, and use it on every stock anyone ever tries to sell on you, including the ones we can get excited about. Don't ask, is this company winning today? It's an easy question, and it's mostly yes. Otherwise, they wouldn't be on the stock market or wouldn't be profitable. Plenty of doomed companies are winning today. But the real question is, what exactly is stopping everyone else from copying them? And how long do you think that actually stays true? And if you can explain why a company is winning, but you can't explain why nobody can copy it, you haven't really found a mode, but more of a head start. And the clock is already ticking, because business is killing. Nobody gets away with a free meal. Thanks so much for listening to the Dutch Investors Podcast. If you want to help us out, please leave us that 5-star review if you've got five seconds to spare, and hopefully we'll see you next week. And like always, stay curious, keep learning, and happy investing.