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:
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
QUALCOMM, Inc. (NASDAQ:QCOM) – Qualcomm “markets digital wireless telecommunications devices”. What does that mean? Lots of things. They allow truckers to get from point A to B with in-cab computers. They also collect royalties on all 3G and 4G capable devices sold. That means for the several years and for the foreseeable future, Qualcomm makes a LOT of money on mobile. Mobile is the present and the future. That’s a pretty stout moat for Qualcomm and they realize it. They have made moves recently to build up a “Patent Fortress” to protect it. Sound familiar?
Moat: Intellectual property
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