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Morningstar | The Efficient Scale Moat Source Is Built on the Presence of Distinct Industry Characteristics

Efficient scale is perhaps the least intuitive of the five moat sources that Morningstar identifies as drivers of sustainable competitive advantage. It typically applies to firms that serve a market of limited size, in which potential competitors have little incentive to enter because doing so would lower the industry’s returns below the cost of capital.

We highlight eight distinct market characteristics that can indicate the presence of efficient scale. Although we observe efficient scale across nearly every sector, it is most common in highly regulated and capital-intensive industries, such as regulated utilities, communication services, midstream oil and gas, REITs, and railroads.

Few markets are conducive to efficient scale characteristics, so it's among the rarest moat sources across our coverage. However, efficient scale companies are least likely to convey a wide moat. Firms in these markets rarely have other competitive advantages to protect against unexpected changes in market structure and are therefore the most likely to possess only a single moat source. Compared with other moat sources, efficient scale firms have historically generated lower returns on invested capital, owing to high capital intensity and the notion that regulation can limit upside for profitability.

For a deeper dive into the efficient scale economic moat source, refer to our September 2018 Economic Moat Source Series: Efficient Scale.