An economic moat is a competitive advantage that one company has over others in its industry. By their very nature, economic moats are difficult to replicate. An economic moat acts as a strong defense against competitors and can ensure that a company can earn larger than average returns over a long period of time.
Moats are not very common. However, most moats are formed in similar ways. The most common source of moats include:
There are many things that on the surface seem like economic moats but are not really. These things may make the company extremely strong and temporarily give them an enormous boost in profits but they rarely make a long term economic moat. Such things include:
Microsoft - Microsoft has one of the largest economic moats around. Their two core products, Windows and Office, create network effects that prevent other companies from being able to compete effectively in the marketplace. Not only does Microsoft have one economic moat working for it, it has two. Switching cost plays a crucial role in keeping it's dominant position with Microsoft Office. There are many other competitors, some of which are even free (the best price) but it maintains its position partly because of the network effect but partly because the cost of trying to retrain all the people who know how to use Office, Excel, and PowerPoint would be too great.
E-bay - E-bay's economic moat comes from a network effect as well. People sell items on e-bay because that is where the buyers are. People go to buy things on E-bay because that is where the sellers are. This creates a virtuous circle where the network becomes larger and larger because it becomes more and more useful to both buyers and sellers.
Common Sources of Moats
Moats are not very common. However, most moats are formed in similar ways. The most common source of moats include:
- Network Effects
- Unique Location or Assets
- Switching Cost
Mistaken Moats
There are many things that on the surface seem like economic moats but are not really. These things may make the company extremely strong and temporarily give them an enormous boost in profits but they rarely make a long term economic moat. Such things include:
- Dominant Market Share
- Superb products
- Strong Management
Examples of Economic Moats
Microsoft - Microsoft has one of the largest economic moats around. Their two core products, Windows and Office, create network effects that prevent other companies from being able to compete effectively in the marketplace. Not only does Microsoft have one economic moat working for it, it has two. Switching cost plays a crucial role in keeping it's dominant position with Microsoft Office. There are many other competitors, some of which are even free (the best price) but it maintains its position partly because of the network effect but partly because the cost of trying to retrain all the people who know how to use Office, Excel, and PowerPoint would be too great.
E-bay - E-bay's economic moat comes from a network effect as well. People sell items on e-bay because that is where the buyers are. People go to buy things on E-bay because that is where the sellers are. This creates a virtuous circle where the network becomes larger and larger because it becomes more and more useful to both buyers and sellers.
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