Warren Buffett and Charlie Munger have called them "moats." Harvard Business School professor Michael Porter called them "barriers to entry" in his famous 1979 article "How Competitive Forces Shape Strategy." 

Factors that make it difficult for competitors to enter a market mean enormous power for any company that's already there. Typically, with power comes profit.

Illumina (ILMN -0.85%) has established one of the most powerful moats in recent memory. A maker of equipment and tools for genetic sequencing, the company has rewarded investors handsomely since its July 2000 IPO. Looking to the future, can it maintain its market-leading position and continue paying off for shareholders?

the double helix of DNA

Image source: Getty Images

A historic milestone and rapid cost reduction 

The first complete sequencing of a human genome -- more than 3 billion base pairs of DNA -- was finished in April 2003. Excitement over this achievement spurred the quest for cheaper, higher-throughput sequencing machines that could make the technology accessible for broader research. Solexa stepped in with the Genome Analyzer in 2006 and was acquired by Illumina the following year. The company's innovation since that purchase has been the primary driver in reducing the cost of sequencing a human genome from $100 million in 2001 to less than $1,000 today.

In fact, the company promises its newest line of NovaSeq machines will bring the cost to a once unbelievable $100. These ongoing price reductions have expanded the market beyond a few well-funded labs to the broader research community. Estimates now show the sequencing market growing to $25.5 billion by 2025.

The product produces data; the data produces profits

And that market is likely to continue growing for decades. As of 2016, less than 0.01% of the world's population had been sequenced, and  -- similar to Tesla's advantage in autonomous driving data -- Illumina is creating a self-reinforcing moat in the form of the information gathered by its sequencers. In an industry preparing for decades of growth, such an early lead can be almost insurmountable.

Let's use the electric car company as an example. At the beginning of 2020, Tesla had more than 700,000 autonomous vehicles on the road. Each of those vehicles produces data that is used to improve autonomous driving algorithms, improving vehicle performance and safety. Therefore, more and more consumers in the market for autonomous vehicles are likely to choose Tesla -- and that cycle produces an ever-widening gap between the company and new entrants hoping to take part in the booming growth industry. Just how big an advantage does Tesla have over its nearest competitor in real-world data? Waymo, the self-driving project under Alphabet (GOOG 0.60%), had only 600 vehicles on the road as of 2019. 

Similarly, more than 90% of the data generated from genome sequencing has been produced on an Illumina machine. The company offers a suite of software solutions to help researchers collect, store, and analyze the vast amounts of data required to achieve clinical breakthroughs. In last month's earnings call, management also announced the acquisition of BlueBee, a software company that "[enhances] the ability of users to gain insight from genomic data."

And Illumina's presentation at the January 2020 JP Morgan Healthcare Conference showed just how fast the company is building its lead. Since 2010, Illumina has increased its customer count tenfold and the amount of its data more than 50 times over.  The dominance is clear in market share as well. Illumina's $3.3 billion in 2018 sales was twice the amount achieved by its next nine largest competitors combined. These are the kinds of numbers investors love. 

Winners keep on winning

Shareowners who've held on to this dominant business have been rewarded with eye-popping results. Illumina has returned more than 4,300% since its 2000 IPO and almost 23% per year, compounded, since 2010.

But healthcare investors should resist thinking all of the company's gains are in the past. Businesses with a dominant position in a fast-growing industry are rare, and when they gain that advantage, they tend to maintain it for decades -- to shareholders' benefit. One of the best ways to profit from our continuing study and understanding of the human genome is to buy shares in Illumina and hold them for decades.