Economic Moat Business Definition + Examples

An economic moat is a business’ ability to maintain competitive advantages over its competitors in order to protect its long-term profits and market share from competing firms 1 . Just like in the traditional sense, a moat is the company’s line of defense that protects it from its competitors. It differentiates and thus uplifts the brand in the market, giving it the edge to perform better in the long run. The term wide economic moat refers to the competitive advantage that protects a company’s place in the market over the long term. Companies with a wide economic moat make it difficult for their rivals to wear down their market share.

List of Business Moats

This includes things like proprietary technology, patents, brands, and licenses that allow a company to protect its production process and charge premium prices. As discussed in the lemonade stand example, a cost advantage that competitors cannot replicate can be a very effective economic moat. As you can see, a company’s economic moat represents a qualitative measurement of its ability to keep competitors at bay for an extended period of time. A durable competitive advantage is an advantage that allows the company to survive (and thrive) despite competitive businesses trying to make money in the same way. Or, for another example, say you’ve started up a challenger brand in the food delivery app space. You’re offering customers much the same experience, but there’s nothing unique about your app.

Some of the reasons a company might have an economic moat are more difficult to identify. For example, soft moats may be created by exceptional what is a moat management or a unique corporate culture. While difficult to describe, a unique leadership and corporate environment may partially contribute to a corporation’s prolonged economic success. The average age of a company listed on the S&P 500 exchange is now less than 20 years, down from 60 years in the 1950s. Technology has disrupted how companies do business, making it more difficult to sustain a competitive advantage over time. And when he’s making an investment, he asks the simple question of whether or not the business is going to be more productive in 10 years than it is today.

1. One aspect to consider when analyzing a company’s moat is its valuation.
2. Get instant access to video lessons taught by experienced investment bankers.
3. And when he’s making an investment, he asks the simple question of whether or not the business is going to be more productive in 10 years than it is today.
4. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance.

While certain stocks may appear expensive based on their share price, it is crucial to assess their total market value. For instance, owning 10 shares of a stock valued at $10,000 each is equivalent to owning a single share of a stock priced at $100,000. Evaluating the company’s revenue alongside its valuation can provide insights into whether the stock is overvalued or not. The economic moat will be evident in a company’s unit economics in the form of consistent operational performance and profit margins on the high-end relative to the industry average. If a business is said to have an economic moat, or “moat,” for short, then it has a differentiating factor enabling the company to hold a competitive edge.

Intangible assets such as brand or strong client and people relationships are powerful but take a long time to build up. The more efficient a company can convert its operating cash flows into free cash flow (FCF) – i.e. FCF conversion and FCF yield – the more cash flows are available to use to obtain a higher return on invested capital (ROIC).

Hence, the Apple product users tend to be some of the most loyal customers, which directly coincides with more long-term recurring revenue. The more difficult it is to switch to a rival offering – either due to monetary reasons or convenience – the stronger the moat is around the incumbent, or, in this case, Apple. Like many of the other castles on the list, it has secret passages, a drawbridge and moat, a chapel and a torture chamber — but this Napa Valley castle offers wine tastings as well as tours. A massive gate in that interior wall looks like something out of a medieval castle — all that’s missing is a moat and guards.

If a company consistently has a better margin profile than the rest of the market, then this is typically one of the first signs of an economic moat. Simply put, moats in business refer to the unique, differentiating factors that cannot be easily replicated nor imitated by competitors. Hence, the necessity for companies to build a moat, which is essentially a mechanism to deter new developments in the industry and threats that pose a material risk to their long-term viability. These factors can be related to situational or economic, or they may be put up by the dominant force in the market.

Does my startup need a moat?

In financial terms, a ‘moat’ refers to a sustainable competitive advantage that allows a company to maintain its market position over an extended period. This concept, popularised by Warren Buffett, emphasises identifying companies with strong and defensible competitive positions. Essentially, businesses with economic moats have unique qualities that can shield them from competition and enable them to generate robust profits. The company’s promoters, the Genomal family, have managed to secure a 20-year contract for their franchise, while standard contracts in the industry typically last for five years. This extended contract duration provides Page Industries with a massive competitive advantage, acting as a moat that protects its market position.

What are Moat’s and the importance in the Startup Ecosystem

However, as a final note, it’s important that you don’t get complacent. Sometimes a specific regulation or trend comes about, and a company is uniquely positioned to capture and lock clients (see switching costs). It is a weaker moat as it is only a matter of time until competitors enter the space if it is a lasting opportunity. In the early stages, moats are difficult or nearly impossible to demonstrate. The focus is to engage users with a product that works as seamlessly as possible. However, founders and investors must envision how this business will build moats over time.

However, it should be something that the founders are thinking about, because investors are certainly going to want to know how the startup will protect its valuable and innovative ideas. 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”. A business that has a monopoly moat is the only provider of a service. When I draft an email for my weekly newsletter, I do the same amount of work if I send that email to one person (which was actually the case when I started) as I do now to the thousand+ people on my email list. A strong brand means the consumer is going to get exactly what they expect, every time. But because of its network effects (everyone and their mother is on Facebook), the company continues to thrive.

Economic Moat

But Coke’s secret recipe (and strong brand moat) has kept it in business for 125+ years. A narrow moat is a single advantage and, while it is an advantage, it is also far easier to erode and can be expected to disappear as competition comes calling. However, deployed well, it can be an enormously effective short term moat that contributes towards the development of other types of moats. Network effects driving organic customer acquisition or marketplace liquidity are one of the most important drivers of tech companies. They help leverage quickly the significant reach and growth internet products can have.

1. At this point it’s worth noting briefly that while competitive advantages and economic moats are related, they are different concepts.
2. Many would argue that the network effect (often abbreviated to “nfx”) is the single most potent moat—especially in the tech space.
3. This approach favors businesses with sustainable competitive advantages, promoting a more selective and thoughtful investment strategy.
4. Thus, if a company has an economic moat, sustainable long-term value creation can be attained.
5. Companies can increase their cash flow and can guarantee returns for their investors by narrowing out other players by creating a competitive advantage.

Modern usage

Startups should focus on building and strengthening their moat over time, and it should be a never ending process so as to remain one step ahead in the market. Economic moats are generally difficult to pinpoint at the time they are being created. Their effects are much more easily observed in hindsight once a company has risen to great heights. Large companies that compete in a given industry tend to dominate the core market share of that industry, while smaller players are forced to either leave the industry or occupy smaller “niche” roles. Economic moats are difficult to express quantitatively because they have no obvious dollar value, but are a vital qualitative factor in a company’s long-term success or failure and in the selection of stocks.

An example of this is Unacademy which utilized the need to break through in the segment of hypercompetitive exams like civil services, public sector banks, medical and engineering colleges. Individually, the target audience for each of these segments would be a niche market, but put together they added up significantly. Other common financial analogies include referring to the stock market as a casino, bonds being the anchor of a portfolio, and having no financial plan is like skydiving without a parachute. As a result, you see an increase in profits; however, it probably wouldn’t take very long for your competitors to notice your method and employ it themselves. Therefore, in a short period of time, your large profits would erode, and the local lemonade industry would return to normal conditions again.