When I look at the strongest performers in my own portfolio, I often see powerful moats.
Intuitive Surgical (ISRG -0.35%) is a beautiful example of a razor-and-blades company in the healthcare space. Shopify (SHOP 0.14%) is a dominant internet company with over 1.7 million subscribers around the world. Lastly, Silvergate Capital (SI -2.44%) has established a powerful banking network for institutions that want to trade cryptocurrencies. Here's how these three companies rely on moats to survive and thrive.
Image source: Intuitive Surgical.
Moat No. 1: Razor and blades (Intuitive Surgical)
Intuitive Surgical is famous for its surgical robot that is more precise than human hands. In 2020, Intuitive sold 936 da Vinci surgical robots to hospitals around the world, for an installed base of almost 6,000 robots. Each one costs a hospital about $2 million. If we include the accessories that hospitals bought with the robot, Intuitive made $2.4 billion in new orders last year. Not bad, right? But that's just the beginning of the story.
Consider that Intuitive had $4.3 billion in overall revenue last year, because each and every robot continues to make money for Intuitive. Service revenue added $723 million to the company's top line last year, and systems revenue added a cool $1.2 billion. In other words, while 55% of Intuitive's revenue last year ($2.4 billion) came from new customers buying the robot, 45% of Intuitive's dollars ($1.9 billion) came from actual use of all the robots.
That's the classic razor-and-blades model, and it is a sweet arrangement. While hospitals make a sizable up-front investment in the robot, that's only part of the moat. Another aspect is that doctors train on the robot to learn how to use it. Physicians used the da Vinci robot to perform 1.2 million surgical procedures last year. As Dr. Benjamin Davies, a professor of urology at the University of Pittsburgh, told Nature magazine, when it comes to prostate cancer surgery, "the die is cast; there is only robotic surgery."
Moat No. 2: Subscriptions (Shopify)
One of the more powerful business models out there is software as a service (SaaS). Software can be very sticky because companies rely on it and often build their business on top of the software. That creates high switching costs, forming a large moat that keeps competitors at bay.
Do you want to compete with Amazon (AMZN -1.16%) in online sales? Shopify will help you. It will build your website, and help you with payment options, inventory management, fulfillment, marketing, and all the other things that Amazon does so well. You can start with the basic plan, costing $29 a month. As your business grows, you might expand to the ordinary Shopify account ($79 per month), the advanced Shopify account ($299 per month), or Shopify Plus ($2,000 per month).
You can see how this business creates a powerful moat. If you're running your internet business on Shopify, it would be expensive and painful to disengage and switch to a competitor.
While we're on the subject of moats, think about Amazon's moat for a minute. The company has a powerful brand in online commerce. That's why it had a 39% market share in online retail sales in 2020. Yet Shopify has managed to make remarkable headway against the $1.6 trillion internet behemoth. In a little over a decade, Shopify's network was responsible for 8.6% of retail commerce.
It's done so not by a direct attack (Shopify isn't a retailer) but by arming all the other retailers in the world. Shopify is attacking Amazon on the back end, with all its software capabilities, and allows small mom-and-pop websites to focus on their own brands and marketing dreams. Speciality retailers with small websites can now give their customers an Amazon-like experience in shopping. And speciality retailers often have advantages in know-how over Amazon (a general retailer) when it comes to what its customers want.
Moats aren't impregnable. They just make it harder for competitors to flourish. Shopify has figured a brilliant strategy for finessing Amazon's moat. And now Shopify has its own moat protecting its own business.
Moat No. 3: The network effect (Silvergate Capital)
One of the most amazing moats is the network effect. It's why companies like Facebook and eBay are so valuable today. The more people who use a network, the more valuable that network becomes.
Silvergate Capital is a bank that supplies a financial network for cryptocurrency trading called the Silvergate Exchange Network (SEN). Silvergate facilitates financial transactions for many of the trading platforms and institutions that want to trade Bitcoin (CRYPTO: BTC) and other forms of crypto.
In typical rule-breaker fashion, Silvergate was first mover in an important, emerging industry. It noticed the rise of cryptocurrency in 2013, and actively sought crypto trading platforms and institutions as banking clients. In order to woo industry leaders, the bank created SEN, a financial exchange allowing crypto to be traded 24/7. This was wildly successful: Silvergate landed multiple trading platforms as banking clients, including Coinbase.
Anyone who wants to trade crypto on a platform like Coinbase must first deposit dollars at a bank like Silvergate. Then when a crypto trade is made on the Coinbase platform, the dollars at Silvergate shift accounts. Silvergate makes money because it doesn't have to pay any interest on the dollars deposited at the bank.
Silvergate Capital is a tiny company right now, with a $4 billion market cap. But it already has a powerful moat in place, and it's getting bigger all the time: $9 billion in cash was traded on SEN in the fourth quarter of 2019, and that number jumped to $59 billion in the fourth quarter of 2020.
All this growth makes SEN more and more valuable. Institutions and trading platforms want to deposit money at Silvergate, because you need trading partners to trade, and that's where you find them. As SEN gets bigger, it becomes more valuable, and the moat becomes stronger. And all these deposits at Silvergate give the bank more and more options for making money.
Speaking of networks, cryptocurrency has its own network effect. The more people who join the crypto craze, the more valuable crypto becomes. Network effects are how money works.
While no moat is invulnerable, Silvergate, Shopify, and Intuitive have powerful advantages over rivals. It's always a good idea for investors to think about moats, whether it be the razor-and-blades model, software subscriptions, or the network effect. These are powerful forces that can keep your stocks going up and up and up.
