Step 1: brand = cash
Intangible assets are things such as brands or patents that bring money to a company because they increase a consumer's willingness to pay. Visa has a strong brand, but I'm going to flunk it in this case because it doesn't encourage consumers to pay more solely for the brand. For example, a consumer may choose Visa over American Express
Step 2: Bigger means better
Cost advantages apply particularly to companies with economies of scale. The bigger you are, the sweeter procurement contract you can often get. Last year, Visa had 1.8 billion cards in use. MasterCard
Step 3: Ball and chain
Switching costs in this industry all depend on the type of credit card you have. Sometimes it's harder to let go of a card than you'd like. For example, take my Alaska Airlines
In the case of credit cards, switching costs don't prevent consumers from using another card; they prevent them from canceling the current one. All credit card companies can benefit from this reality, but Visa passes this test because it has the most cards in circulation.
Step 4: Safety in numbers
Visa is the most-used credit card in the world, based on the most recent transaction numbers. Its 62 billion annual transactions are nearly double MasterCard's 32 billion and obliterate Amex's comparatively measly 5 billion. This network effect is a double-edged sword for the competition. Startup businesses will be more likely to bring on Visa than Amex because they know more people use Visa. Conversely, if more businesses accept Visa, more consumers will opt for that card. This presents a huge barrier to entry for new credit card competition. Visa nails Step 4.
Evaluating the durability of competitive advantage is a great way to think about a company beyond the balance sheet, but an economic moat isn't guaranteed to last forever (new ways to pay, for example, could really shake up this industry). As you ponder your company's long-term potential, think about how long you intend to hold the stock. If the moat lasts longer than you wish to hold the stock, great! Or you may only wish to hold the stock for as long as you think the moat will last. Either way, the moat test is key to understanding a company's long-term potential.
Fool contributor Aimee Duffy loves to rock the moat. She doesn't own shares of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Visa and Discover Financial Services. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.