Robust companies that accumulated efficient scale have established themselves in a certain market segment and can potentially provide ETF investors a reliable investment opportunity.
“Efficient scale is a dynamic whereby a market of limited size is effectively served by one or a small handful of companies,” according to Morningstar. “In many of these situations, the existing players earn economic profits, and a potential competitor is discouraged from entering because market entry would cause returns in the market to fall below the cost of capital.”
Brandon Rakszawski, ETF Product Manager for VanEck, explained in a note that these types of companies with efficient scale can be seen as a type of natural monopoly where companies are efficiently scaled to supply a market that is only big enough to support one or a few competitors, which limits competitive pressures.
Additionally, fort thinking about pushing their way into this segment dominated by a company with efficient scale, a market entry often requires very high capital costs, which are not justified by the limited profit potential a new competitor might achieve.
Efficient scale is often found in companies involved in telecommunications, utilities, railroads, pipelines and airports.
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For example, CSX Corporation (NasdaqGS: CSX) exhibits a wide economic moat, according to Morningstar, based on cast advantages and efficient scale. The company is a rail transportation company that operates in the Eastern U.S. and controls 20,800 miles of track, moving coal products, chemicals, intermodal/shipping containers, and other merchandise. Given its wide network of tracks and physical assets in place, it is nearly impossible for a new entrant to replicate in a competitive fashion.
United Parcel Services (NYSE: UPS) is also known for its efficient scale, along with cost advantage and network effect. The company has established an integrated international shipping network that is unlikely to be matched by few global competitors due to its extensive physical assets already in place, which would be very costly to replicate.
To capitalize on this efficient scale attribute, investors can take a look at the VanEck Vectors Morningstar Wide Moat ETF (NYSEArca: MOAT), which implements Morningstar’s wide moat methodology. MOAT is up 16.2% year-to-date, compared to the 15.5% gain for the S&P 500.
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