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In reading the news last week of Eastman Kodak (EKDKQ.PK) filing for bankruptcy, I was reminded of the importance of an economic moat. For newer investors, economic moat is a term that Warren Buffett made famous that describes a company's competitive advantage. For nearly a hundred years, Kodak was the preeminent photography company in the United States. Some can argue that other companies made better cameras, lenses, or film, but no company was better at bringing photography to the masses. Its developing process, associated patents, and distribution centers provided an unparalleled model for dominating an industry. As a result of its dominance, Kodak paid shareholders handsomely with consistent dividends for more than forty years. Ironically, it was one of Kodak's own patents that became its undoing: digital photography. That is, Kodak literally invented how to digitize photographs and while it still rakes in money for some of those patents, it missed the paradigm shift in the market. During the eighties and nineties, Kodak management didn't understand how to make the switch to, or better still, build a market for digital photography. This fundamental flaw greatly contributed to the downfall of Eastman Kodak. Did you know that out of desperation, Kodak even briefly diversified into pharmaceuticals?

Currently, Kodak competes in the digital camera and digital printer markets. Despite a refocusing on its core businesses, it never recovered financially and stopped its quarterly dividend in 2001, opting for a semi-annual dividend from 2002 through 2008. Kodak is not alone in falling from dominance. Did you know that Xerox (NYSE:XRX) was once on the cutting edge of computers? This company invented the pre-cursor of the personal computer (including the mouse) in the late sixties. Xerox was sitting on one of the more powerful inventions and new markets in the last century. Do you know what happened? Steve Jobs was allowed to visit its researchers and look at these tools for what they were: the future. Today, Xerox is known for many things, but computing is not one of them; neither is it known for a steady, growing, or reliable dividend. While Apple (NASDAQ:AAPL) has a market capitalization of nearly 400 billion dollars, Xerox is worth just twelve billion. Granted, just because a company invents a product doesn't entitle them to the future profits, but it does represent missed opportunity. In both cases, Kodak and Xerox were either fearful of upsetting their current markets or just didn't understand that they were in possession of a product that could ignite a new market.

These are important factors in evaluating companies and their perceived economic moat. While it is part product or service, it is also recognition of opportunity and new horizons and how senior management not only competes, but dominates a market. A few years ago, I read that Intel (NASDAQ:INTC) was developing computer chips for mobile devices. It was a blasé story about a large company diversifying into a growing market. However, I was intrigued because Intel has recognized opportunity and changed paradigms before. In the eighties, under CEO Andy Grove, Intel was the preeminent company for development of computer storage. By all measures, they were a successful growth company. However, Mr. Grove saw that the markets were changing. More and more, storage was seen as a commodity that could be more easily and cheaply manufactured abroad. This was the same time that personal computers were taking hold and Intel recognized that investing in developing more computing power was the future, not storage. Mr. Grove called this a strategic inflection point. After much consternation over completely reorienting his company, it successfully made the transition into chips for which it is known today. To wit, I was intrigued by Intel's move into a new market. In addition, everywhere I went someone had at least one mobile device. I said to myself, Intel is evolving and positioning itself to dominate again. Today, Intel has positioned itself as one of the best mobile chip makers in the world. I recently read that in 2011 one billion of the world's approximately four billion mobile devices are smartphones. This statistic is only growing; it is estimated that the number of mobile devices will overtake desktops by 2014. By any measure, this is a large, growing, and lucrative market and consequently a potentially great dividend investing target for many portfolios.

Another stalwart dividend paying company has done the same reinvention act. Anyone ever heard of International Business Machines (NYSE:IBM)? In earlier days, IBM was synonymous with computers not made by Apple. You had either one or the other, right? However, as the personal computer market matured and it became evident that this business could more easily and cheaply be done abroad, IBM divested itself by selling its computer business to a Chinese company called Lenovo (OTCPK:LNVGY). At the same time, IBM invested heavily in consulting on technology integration and cloud computing. It doesn't hurt that IBM continually files for and wins the most patents among all companies nearly every year. Today, IBM is more a software- than hardware-company. It has spurred a similar migration among its competitors from Hewlett Packard (NYSE:HPQ) to Dell (NASDAQ:DELL). All of these companies now receive a large portion of its revenues from the software side of the business.

So, why did I write about these stories of success and failure? It boils down to understanding economic moats. Times change, new technologies disrupt, processes change, and international economics matter. It is a mercurial aspect of investing that should not be ignored or overly-simplified through quantitative analysis. One must be a student of markets and management and recognize those strategic inflection points. One must have the mind-set to see past the current quarter's balance sheet. One must look long term and understand the dynamics of a particular market.

I have read many articles on this forum and learned a tremendous amount concerning the fundamental health of Company A's free cash flow or the relative strength of Company B's dividend growth rate. However, I haven't read much in-depth discussion about economic moats. I will close by asking readers what they pay attention to when they think of economic moats. Perform a mental exercise; are you willing to bet the future of your dividends that the companies in your portfolio are maintaining their competitive advantages? For example, where will Altria (NYSE:MO) be in 10 years? Has Nike (NYSE:NKE) created a new market by integrating technology into sports training? I look forward to reading your comments.

Source: Thoughts For The Dividend Investor: Importance Of An Economic Moat