“First of all, I think moats are lame. It’s nice, sort of quaint in a vestigial way. If your only defense against invading armies is a moat, you will not last long. What matters is the pace of innovation. That is the fundamental determinant of competitiveness.”-Elon Musk
If you give a man a hammer, he finds everything needs pounding. If you teach an investor about moats, they will find a moat in every investment. Moats are a great concept, but they are overapplied. Technically a moat is a “durable competitive advantage.” How is counter-positioning a “durable competitive advantage?”
Below are a few examples of commonly mentioned moats that really aren’t moats;
- Counter-Positioning – The idea is that conflicting interests of your competitors can protect your business. A commonly cited example is Barnes & Noble versus Amazon. In order to stop Amazon, Barnes & Noble would need to cannibalize their core business. The logic makes sense, but how is that durable? And did this protect Amazon from other e-commerce competitors?
- Network Effects – It takes major effort to build a network. One would intuitively think that network effects would be a moat. The problem is, while they take major effort to build, networks can erode quickly. Numerous examples exist, but quick examples would be MySpace and Craigslist.
- Brands – This is a tough one. Some businesses really do have brands as a moat (Apple, Coca Cola, etc…), but I wouldn’t count young companies’ brands as moats. A great example is Peloton. While a great brand with huge pricing power, is it durable? Anybody confident in the answer to that question is a liar. Brands are great to have, but need to be proven durable to be a moat.
The reality is that people lie to themselves to make themselves feel safer in their investments. Having a castle without a moat is scary. Thinking a moat keeps your castle safe is more dangerous. Putting your faith into a business and trusting that it will protect itself without a durable competitive advantage is scary, but that is the reality of investing in young innovative businesses.
To be clear, many moats do exist. High switching costs, regulation, mature brands and intangible assets are all very real moats. The reality is that most companies don’t have moats. Some are trying to build moats, but most will fail. And those that do have moats often proceed to mortgage them. I love the concept of moats, I just worry it is overapplied. It’s a concept that’s easy to understand and makes you feel safe in your investments. And don’t try to bring Buffett into this conversation. The difference between you and Buffett is he buys companies that have moats, while you buy companies and then fantasize they have moats. Be like Buffett.