Popularised by Warren Buffett, the idea of business moats is simply some kind of persistence or stickiness in demand that businesses have, which can keep them going. Basically it is really anything that helps to reduce competition to a business. This is important in the real world though we tend to celebrate competition in economics. Business moats are actually necessary for innovation, and avoiding a race to the bottom.
Moats are largely about maintenance of a profit margin. The stronger the moat, the higher the margin would be but having a moat itself makes a lot of difference. In fact, we tend to worry in economics about moats because we think it creates high margins. That’s not always true. You could have low margins as a moat itself – because being able to keep your costs low would keep competitors at bay. The point of moats is more about the persistence of the margin.
The most significant problem with competition is that you are in a dynamic environment that keeps you on your toes. Now you may think that is a good thing. But if we keep having to compete with competitors who are just diverting your customers easily through one-off gimmicks and popping up in different places, dislodging your margins here and there, it is not going to make a significant dent in your profits, but it certainly takes up your attention and ability to consider longer-term growth and innovation.
It is such long-term thinking that a business moat creates, which can support the maturing of a system. Yes, other institutional factors contribute to the growth and development of markets. But pure ‘perfect competition’ in the manner it is traditionally thought isn’t one of them. Many developed countries and markets have that sort of dynamism and competition. Just go to a weekday market in a mid-sized town in Africa. But that in itself does not produce the sort of progress that capitalism is touted to produce.
What underlies the success of market capitalism is ultimately the ability not just to accumulate capital but to be freed of that savage competition to engage in more medium to long-term strategic competition. And that is enabled by business moats.