Moat theory and it's discontents

Moats, mottes and baileys

One of the ideas I'm often surprised that has not really entered business life more is that of "moats".

A economic moat is something a company has which prevents other companies from enter it's market and being able to compete with it. A few examples.

LinkedIn. LinkedIn is a social network. LinkedIn has some genuine network effects, everyone is on it and the first step in producing a competitor would be to get everyone else on your platform - which was possible at the moment when LinkedIn started in the 2000s but is much more difficult now.

Prestige brands, often European. Louis Vuitton, Ferrari, Rolex, etc. The product effectively is the brand and that's hard to reproduce. People who want a Rolex want a Rolex for the social signaling it provides and a new entrant's watch can't provide that to them.

Oracle and other corporate IT integrators. They've gotten themselves injected into many corporate IT programmes where they can extract rents but are difficult to extract themselves because it's so disruptive to do so. Amazon, famously quite ruthless internally, took 10 years to extract themselves from the mistake of starting their businesses with Oracle databases.

Regulatory barriers are a common moat. Most countries have a finite number of retail banks, many of which are old and venerable. It is usually quite hard to start up a new bank - you need a banking licence. The UK didn't issue any new ones for over a century. No new banks whatsoever.

Why moats matter

If a business discovers how to do something new in order to make money, others will copy that something unless there is a reason why they can't. That's bad for you: they enter your market and sell the same thing and eventually your profit margins fall until both of you are making the bare minimum you require to survive. It's the business equivalent of being a subsistance farmer: making the absolute minimum amount of profit to survive.

Instead of being a subsistance farmer what you want what MBAs emphasise as "durable competitive advantage": you want a moat.

Cope moats

At the same time, it's important to understand what is not a moat.

Innovation

Innovation is a typical "cope moat". The benefits of innovation to society are lasting but the benefits to a business are actually pretty transitory. When a business invents something new it is usually obvious to others what they have done. And they will copy it unless there is some reason why they can't. There are some legal defences (namely patents) but their effectiveness can vary. Software is often not patentable. Developing countries typically ignore patents and then export into your home country. Innovation: not that great.

Capital intensiveness is also not much of a moat. Many businesses tell themselves that their significant investments mean that competitors cannot compete with them. I never know if they even believe it themselves: money is the most fungible of assets. If it's profitable to do so, others can borrow money and make the same investments.

"Operational excellence"

Being an effective organisation is not a moat. It is critical to understand that being an effective organisation is massively overrated for established businesses. If you've ever worked in a big, highly profitable, company and thought "Why is it so inefficient and difficult to get anything done here" now you know why. Effectiveness, beyond a certain level, is just not that important to the fitness function that operates on businesses.

I sometimes think of it as "Sportsman's fallacy". Many people think of business as a form of sport and that seems to make sense as, after all, there are competitors. To be a successful in sport you have to be really effective: good at training, good on the pitch, good at reflecting on how to perform better. In short: you need to he competitive.

But in business it is actually best to be anti-competitive. To use branding, incompatibility, regulatory barriers - whatever - to keep others out.