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  . 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. Although a competitive advantage can mean any and all factors that can help a company provide goods and services like those of their competitors while doing better than them, it’d be the company’s moat if it helps it keep its standing and outperform in the long run.
For e.g. let’s say you own a company and provide certain products/services that are doing well. While doing so, you figure out a way to reduce your costs, while increasing your profits. This is your competitive advantage – something that sets you aside from your competitors. More clients will get attracted to you, and you’ll earn even more thus increasing your profit. But what if this advantage, which was then so unique to you, could be copied by your competitors, as they see your profits rise? The advantage, and the market, would now get balanced out. However, if your competitive advantage were so unique to you that not only could it not be copied, but it could also serve your company for the long run – thus helping you outperform your competitors – you then have an economic moat.
Types of moats
There are several ways in which a company can create its economic moat. Some ways that you can develop moats are by having a :
- Cost advantage: an advantage that a firm has over competitors in terms of costs which could be due to cheap labor, cheap raw materials, etc. When a company keeps its costs lower it can have a great advantage over competitors who have higher costs (and therefore higher prices of their products and services)
- Size advantage: the advantages that a company enjoys due to its size. Larger firms typically have the advantage of being a more established business and therefore have more access to funding, more repeat business and higher sales and profits, while smaller companies can enjoy the advantages of accessibility and approachability, customisation and speediness
- High switching costs: An advantage seen mostly in B2B solution companies, where switching from one system to another requires huge effort in terms of time, labor and knowledge, or it could be due to better customer service, because customers love the product and services and won’t easily switch
- Intangible assets: such as patents, IP, brand recognition, government licenses, etc. For e.g. Pharma and medical device companies sustain themselves on patents, consumer brands companies focus on the brands, and high software tech companies have strong inhouse technical capabilities which cannot be easily replicated by other companies
- Soft moats: advantages that are not easy to identify, but become more visible as the company grows, e.g. an excellent management or culture. Steve Jobs at Apple built a strong culture of design, a culture that is still ingrained in the company, even with a new management, while Jeff Bezos at Amazon, has built a strong culture of customer obsession
- Supply side economies of scale: means that producers and their willingness to create goods and services set the pace of economic growth, e.g. Walmart and other chain stores have the unique ability to buy its merchandise in bulk, usually at discounts from suppliers, and for suppliers this means that its products are seen by millions of shoppers each day across the globe. This also allows Walmart to negotiate better prices with manufacturers to give better value to end consumers
- Buy side demand economies of scale: This can be thought in terms of marketplaces, as a classic network effect, where each buyer (demand) creates value for other buyers, and cross selling to existing customers also adds to the moat. The best example of this is Amazon, explained further below.
- Data driven moat: Many companies aggregate or collect data and even build personalization and recommendation engine models over it to provide better customer offerings, e.g. TikTok, Google. These companies have strong models to provide better recommendations to their users
- Regulatory approvals: Examples are Spectrum license fees, oil drilling license, telecom spectrum license, NBFC licenses, and any other regulatory approvals that could uniquely help the company provide a service
Moat creation in the startup ecosystem
A lot of startups end up discovering a moat and then reinforcing it over time, but very few actually design a moat and then reinforce it. Some startup founders also rely on capital as their moat, but this is unsustainable in the long run. An initial thought on this is important because, as we’ve discussed, your moat is your unique, longstanding competitive advantage.
So how could an entrepreneur go about designing their company’s moat? One way is to identify a unique market that you can serve – a market where you could ascertain yourself as the dominant player – and then use the insights that you have about the market to your advantage. An example of this is Flipkart, which leveraged its deep insights into building up its logistics capacities with Ekart and significantly cut the turnaround time or time it’d take to fulfill an order. Harness the power of data to draw relevant insights and identify trends.
Another could be to identify several niches that together would make sense, but from afar might not seem as easily put together. 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.
Moats are formed over time. 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.
Some other examples of well known companies
Amazon’s central advantage comes from utilizing the network effect that it has created by aggregating suppliers and customers. By harnessing the power of the marketplace, it was able to scale from a bookseller to an “everything” seller today. It recognized early on that the more people in its network, the lower the prices that it could offer, and could thus attract more customers, sellers and build up a better customer experience. It has expanded into new verticals and added features like Amazon Prime, AWS and its acquisition of Whole Foods, etc. in a bid to increase user engagement.
Uber’s power over supply and demand has been its competitive advantage against competing rideshare companies – its ability to aggregate independent drivers by guaranteeing a source of customers and users by providing them with a guaranteed driver. It extended the geographic reach of its app as more drivers signed up, thus reducing wait time for pickups and providing access to newer areas. It also developed a model which is now known as surge pricing, to ensure that a ride was always available whenever a potential user opened the app. To compete against smaller, more local ride sharing startups, Uber simply upped its incentives for its drivers and provided discounts for its riders.
Gillette is a name that every household is familiar with. And there’s a reason for that, as Gillette, with its safety razors and replaceable blades actually crafted a very powerful business model – the “razor blade business model” as it is called now, built on the principle of sunken cost. The model refers to any business that operates on a combination of low and high margin purchases – a low margin product priced low enough to attract customers, and a high margin product priced just high enough to provide healthy profits, with purchase repetition being the key. This simply means that people who buy cheap Gillette razors then also buy the high margin Gillette blades and keep returning to buy them. Over time, the moat is created, and to protect this moat the value of the product and the brand name is reinforced in the customers mind, which Gillette did through new offerings, brand products and sponsorships
Starbucks is a great example of a cultural moat, a brand built by upgrading something as simple as coffee by giving it the right cultural expression. Starbucks’ introduction of higher quality European roasting and brewing practices made it synonymous with premier, sustainable coffee and its vintage European style décor and exotic names for its cup sizes and drinks made it synonymous with sophistication. The simple act of ordering by name (which the founder explicitly noticed in his European business trips) gave it a degree of familiarity that wasn’t very present before within cafes. Another moat that it created is the Starbucks rewards membership program which, a few years ago, allowed its members to use the Starbucks app to order, pick up and pay. Even though other delivery apps now provide delivery from Starbucks, the membership still provides its members with a lot of benefits, so much so that in 2021, Starbucks announced that Starbuck Rewards purchases represented 50% of the company’s total sales in the US.
There are a lot of other examples of successful companies who have broken through and thrived with building their moats, but the key takeaway here is to focus on the competitive advantage that not only makes your company unique but would also help it stand tall for a long time.