Stock Shastra #6: A company with Patents/Trade Secrets is well protected from competition

Stock Shastra#5 talked about how a great brand can become a competitive advantage (unbreachable moat) for a company. The reason why this happens is because brands are unique and nobody can use or copy your brand name. Once a company creates loyal customers for its brands, and commands a premium, it translates into higher sales and profits. Another powerful moat that can effectively be translated to sales and profits is ‘Patents/Trade Secret’. But how does this moat work?

The answer is Stock Shastra #6: A  company with Patents/Trade Secrets is well protected from competition.

How does a patent or a trade secret work?

What if your company was the only one who was allowed to make a particular product? No other company could produce the same product. If they did, it would be illegal and they would invariably end up facing charges in a court. That is exactly what a patent does. A patent gives an exclusive right to the inventor of a new, innovative and usable product or process to derive benefits from it for a limited period of time. It protects your business as competition cannot copy your product.

With a patent however, you have to disclose all the information related to your unique product. And the life of a patent is usually a maximum of 20 years, after which anyone can produce the product. So, what do you do if you do not want to disclose the way you make your product?

This is where a trade secret comes in. A trade secret can be a formula, recipe or process for making a certain product or providing a particular service. Unlike a patent however, it is not limited for a particular time. Its life depends on how long you can keep it a secret. A famous example of this is Coca-Cola’s formula for the soft drink which has been a closely guarded secret for 122 years. A trade secret confers a slightly different advantage to a company. In Coca-Cola’s case it has given the company a significant business advantage in the ‘carbonated drink’ market, as there is no other cola that tastes the same.

If a product is patented or has a trade secret, the company becomes the only one who can produce it. No other company can compete with it. Consumers who develop a preference for the product continue to buy it, because the other alternatives are not good enough. This leads to higher sales and consequently higher profits.

Which companies fit the bill?

So, which companies have this moat? Obviously the first thought that comes to our mind is that of Pharma companies. Pharma companies like Dr. Reddy’s Labs, Sun Pharma, Cipla, Ranbaxy, Biocon have patents for the new chemical compounds or compositions that they discover. However, companies from other sectors can also have patents.

Bilcare Research, a company that we have covered in Company Shastra is such a company. Belonging to the packaging sector, Bilcare serves the packaging needs of Global Pharma companies. It has patented technologies like Bilcare Optima and Brandpak Building Solutions which alongwith its patented materials and designs have helped the company become a market leader.

IT companies also have patents for their improvements in computer technology. Infosys, for e.g has 5 approved patents and has as many as 216 patents pending approval. Other companies like Wipro and TCS are also research driven companies and file for a large number of patents every year.

One of the leading auto majors of India, Tata Motors has filed more than 400 patents and design applications for its various vehicles and processes.

FMCG companies manufacturing personal care products like Procter and Gamble, Colgate, Hindustan Unilever will usual have trade secrets for their products. Similar is the case with companies producing food products like Brittania, Nestle India etc.

The large number of patents filed by these Indian companies indicate the importance given by them to patents. These companies spend around 6% of their turnover on research and development. Companies like Tata Motors, BHEL, Dr. Reddy’s Labs and Sun Pharma have infact featured amongst the top 1000 largest R&D spenders in the world. This indicates the focus of these companies on the research and development of new and innovative products – a must for remaining successful over the long term.

In Stock Shastra #7 we will look at the next moat that a business can have, Toll.

You should also read the following:

1. Stock Shastra #1: Stock Investing is not Rocket Science!
2. Stock Shastra #3: You just need to look at 5 Financial Parameters to shortlist a wonderful company!
3. Stock Shastra #4: Look for companies with unbreachable moats
4. Stock Shastra #5: Great Brands are an unbreachable moat
5. Company Shastra – Bilcare Ltd.