In my experience, businesses only have three types of barriers to entry:
(1) Differentiation – Their product and/or service is unique in some way
Most businesses think they fall into this category, but few really do. An argument could be made that Apple did for a while with the iPod, iPhone and so on, but now smartphones are a commodity and their brand equity is slowly eroding (in my opinion).
Likewise, many businesses try to build their brands such that they have this “something different” appeal.
And then there is actual true intellectual property (IP)! For example, a business that owns the patent on a pharmaceutical or owns the code of Google, and so on. Some of these advantages stray onto the “legal” barrier of entry, but where the legal is “self-built” (i.e. IP), I argue that this is in fact just differentiation, as your competitors are free to build their own IP in this space.
In South Africa, I think Blue Label Telecoms (BLU), Ansys (ANS), and AdaptIT (ADI) would fall into this category. Perhaps Naspers (NPN) too, via Tencent (not via its old media assets).
(2) Cost – Their cost-base is efficient, allowing them to attractively price their products and/or services
Everyone knows that being low on the cost curve is key for a mine. Well, it is actually pretty much key everywhere else too. Some businesses only exist because they are efficient and can do things cheaper than everyone else.
Here returns to scale that lower your “fixed cost per unit” also start to become barriers to entry, but predominantly this revolves around efficiency in everything.
For example, Capitec (CPI) is a clear winner in the retail banking space. The real reason Capitec is winning here is because it lacks the high-cost, legacy banking systems that all the other major banks in South Africa have. Rather, Capitec has a nimble, scalable, and modern cloud-based banking system that makes its fixed costs keep dropping and offers a modular branch roll-out that is efficient. This allows Capitec to price retail banking services very, very cheaply and yet still make the highest margins (that I am aware of) in this industry. Win-win.
(3) Legal – It is illegal to compete with them for some reason
Finally, there are legal barriers to entry. These often revolve around licenses. For example, telecos licenses, TV or broadcast licenses, medical licenses, casino licenses and so on.
These are often tricky businesses to set up, but once you have the license (assuming you keep it), you have an artificial near-monopoly (or near to it) and can start to exercise pricing power.
Vodacom (VOD), MTN (MTN), Tsogo Sun (TSH), and Sun International (SUI) are good examples of these sorts of businesses. Even Afrocentric (ACT) with Medscheme and Discovery (DSY) are this to some degree. Note how Blue Label Telecoms has the above differentiation and IP advantage and their ongoing move to buy Cell C would also give them a legal barrier to entry… This is a powerful combination. Worthing thinking about.
In summary, without a sustainable barrier to entry, a business’s margins will eventually get eroded to away by competition. In my opinion, you want to avoid these ultimately mediocre businesses and focus your investments into defendable business models with strong and sustainable barriers to entry.