What is an Economic Moat?
In investing, the term “moat” is used to describe a competitive advantage that a company has over its rivals. An economic moat is a wide and deep moat.
The concept of an economic moat was popularized by Warren Buffett, who is known for his long-term approach to investing. He said that a company’s competitive advantages should be both wide and deep. In order to create a durable competitive advantage, or what he calls an “economic moat.”
Today, we will explore what an economic moat is and how it can give a company a competitive advantage. We will also discuss some of the ways that investors can look for companies with strong economic moats.
Narrow Vs Wide Economic Moat
An economic moat is a competitive advantage that a company has over its rivals. A moat can be either narrow or wide.
A narrow economic moat is a competitive advantage that a company has over its rivals in a single market or product line.
For example, if Company A has developed a new technology that allows it to produce products more cheaply than its competitors, it has a narrow moat.
A wide economic moat is a competitive advantage that a company has over its rivals in multiple markets or product lines.
For example, if Company A has developed a new technology that allows it to produce products more cheaply than its competitors and also sells those products in multiple markets, it has a wide moat.
An economic moat is a competitive advantage that a company has over its competitors. Some examples of moats are as follows:
- Network Effects – Products become more valuable as the number of users acquired increases (e.g. Facebook/Meta, Google)
- Switching Costs – Positive monetary effects of moving to a different provider are outweighed by the associated costs (e.g. Apple)
- Economies of Scale – Cost of production on a per-unit basis decreases as the company expands in scale (e.g. Amazon, Walmart)
- Intangible Assets – Proprietary technology, patents, trademarks, and branding (e.g. Boeing, Nike)
How to Identify a Moat?
There are a few key indicators that can help you identify whether or not a company has an economic moat.
Firstly, we should look at the company’s financials to see if it has been consistently profitable over a long period of time. If it has, this is a good sign that it has a sustainable competitive advantage.
Secondly, you should look at the company’s customer base to see if they are loyal and unlikely to switch to another provider. If they are, this indicates that the company has a strong brand and/or differentiated product that customers value.
Finally, you should look at the company’s competitive landscape to see if there are any barriers to entry that would make it difficult for new entrants to gain market share. If there are, this suggests that the company has a moat.
Moat Example – Use Case (Apple)
An economic moat is a competitive advantage that a company has over its rivals. This can take the form of a unique product, a lower cost of production, or a better distribution network.
Apple has built up a large moat around its iPhone business. For Apple, not only is it expensive for customers to switch to a different product offering, but it is difficult to escape the so-called “Apple Ecosystem”.
If a consumer has MacBook, you can likely bet that the person also owns an iPhone and AirPods.
The more Apple products that you own, the more benefits you can derive from each product due to how compatible and well-integrated they are (i.e. “the whole is greater than the sum of the parts”).
Hence, Apple product users tend to be some of the most loyal, recurring customers.