Around these circles, Warren Buffett, leader of Berkshire Hathaway Inc. (NYSE:BRK.A), is more than a role model. He is a little ‘g,’ god. And rightly so, the man has an unparalleled track record in investment growth. One of the core concepts Buffett has preached over the years is the concept of moats.
“In business, I look for economic castles protected by unbreachable ‘moats’.” – Warren Buffett
What did Buffett mean by the concept of a moat? He meant a barrier of protection (like a moat) between the business (the castle) and all the potential competitors (the invading army). Some moats are little more than a skinny stream competitors can step over easily while others are gushing rivers several hundred yards wide, infested with alligators. He defines it better in a 1999 Fortune Magazine article:
“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.”
Here are a few examples of business moats:
Wide Moats
Apple Inc. (NASDAQ:AAPL) – If you own an iPhone, you probably own an iPad and maybe a Mac. Once you have one, it just makes it easy to get another. Why? Because that all plays into Apple’s diabolical plan (cue deep baritone laughing). iMessage allows users to text from one device and then pick up another to continue the conversation. iPhoto syncs photos across all devices seamlessly. Time Machine ensures users never lose their critical data as it backs up all devices wirelessly. All this makes it REALLY difficult to move away from Apple, even when Google Inc (NASDAQ:GOOG) and Samsung make such appealing devices. They can’t give you that ecosystem that Apple can. At least not yet. . .
Moat: High switching costs
Moat: Intellectual property
Small Moats
Groupon Inc (NASDAQ:GRPN) – My family and I use Groupon to get deals on food, products and even vacations. It really is a great service, but what is to stop a company from offering that deal directly to the consumer? When you really think about it, Groupon is the middle man in the transaction. They get a large chunk of the already discounted rate which squeezes the company selling the product or service. If Groupon gets 30% of the transaction, why wouldn’t the company choose another, similar service that is willing to accept only 20% of the transaction? Ever heard of Living Social? They hopped on a boat and ran into the castle walls full steam ahead. Groupon has suffered in the aftermath and unless they can shore up that moat, will continue to do so.
Moat: Network effect
Dell Inc. (NASDAQ:DELL) – The first computer that I could truly call mine was a Dell. I saw the commercials. The thing I loved about Dell’s business model then was the ability to customize your computer while still getting a great price. Soon, though, other companies figured out how to replicate. Dell certainly did have a moat, but the “durability of that advantage” (in Buffett’s words) was lacking. Computers, all running the same software (Windows), became a commodity. If Dell couldn’t offer the extra storage I was looking for, I would check out another manufacturer. It was recently announced Dell would be taken private after losing over 70% of its value from the days of “Dude, you’re getting a Dell”.
Moat: Cost advantage
When analyzing investment opportunities, it is crucial to analyze the competitive advantage the company has over its competitors. Not only should a potential investment have a wide moat, but it should also be taking active steps to protect the castle by widening its moat or at least putting alligators in the path of those looking to take down the castle.
The article Moats and Boats originally appeared on Fool.com and is written by Robbie Laney.
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