Step 1: Brand = cash
Intangible assets are things like brand or patents that bring money to a company because they make consumers more willing to pay. Verizon 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. While Verizon has benefited from recent poor PR surrounding AT&T's overly congested network, for the most part wireless buying habits are based on pricing. Even though Verizon consistently has the most loyal customers in the industry, compared with other markets like retail, brand appeal in the telecom space is limited.
Step 2: Bigger means better
Cost advantages apply particularly to companies with economies of scale. The bigger you are, the sweeter procurement contract you have. Verizon is currently the nation's largest wireless provider, so it's going to have some weight to throw around when it comes to negotiating prices with suppliers. If I wanted to put a tower up somewhere, it would not only cost me more money, but the cost would have a bigger impact on my bottom line than it would with Verizon. In addition, with the largest carriers having to build out vast networks across the country, Verizon's size advantage can provide more efficient use of cell towers relative to smaller competitors who have to match its footprint with a smaller customer base. Verizon illustrates this scale with its wireless unit's industry-leading profit margin. Verizon passes this test.
Step 3: Ball and chain
Switching costs are pretty straightforward, especially when it comes to wireless providers. Like other U.S. carriers, Verizon utilizes two-year contracts to keep their customers tied to the company. Costs are high to break the deal, which discourages most people from doing it. That helps reduce churn, but it doesn't eliminate the fact wireless companies still offer a commodity-like product. The telecom market doesn't feature exceptionally high switching costs for customers.
Step 4: Safety in numbers
Network effects are certainly something to consider when your company's product is its network. If Verizon tells me that all calls and text messages to people within the network are free and four of the five people I call the most often are on the network, then when it comes time to buy a phone I will probably get on board. If no one uses Verizon, then I probably won't, either. Never underestimate the power of the herd.
Size, switching costs, and a growing network of customers will sustain Verizon's moat for the near future, barring an AT&T and T-Mobile merger, of course.
Evaluating the durability of competitive advantage is a great way to think about a company outside of the balance sheet, but an economic moat is not guaranteed to last forever. As you think about 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 as long as you think the moat will hold up. Either way, the moat test is a 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. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.