What is an Economic Moat?

In medieval warfare, a castle without a moat was just a target. It was easy to storm and easy to take. In modern business, the same rule applies. If you build a profitable company without a defensive perimeter, competitors will invade, undercut your prices, and steal your margins. This defensive perimeter is called a Moat.

A Moat is a distinct advantage a company has over its competitors which allows it to protect its market share and profitability. It is the reason why Warren Buffett invests in Coca-Cola and not in a generic steel mill. One has pricing power and protection; the other fights a brutal war for every penny.

For a startup, building a moat is the difference between a flash-in-the-pan success and a generational company. If you do not have a moat, your success is actually dangerous because it attracts well-funded sharks who can eat you.

New founders often believe their technology is their moat. They think, “We have the best algorithm,” or “Our code is cleaner.”

This is rarely a durable moat. Technology is porous. Engineers leave and take knowledge with them. Competitors can reverse engineer your features. Unless you have a hard patent portfolio (which is rare in software), technology is a temporary head start, not a permanent defense.

True moats are structural. They are woven into the physics of the business model. There are four primary types:

1. Network Effects: The product gets better as more people use it. This is the strongest moat. If you launch a Facebook competitor today, it does not matter if your features are better. Everyone is already on Facebook. The value is the network, not the software.
2. Switching Costs: It is painful to leave. Think of your bank or your ERP system. Even if you hate them, moving your data and retraining your staff is a nightmare. This lock-in allows companies to raise prices without losing customers.
3. Cost Advantage: You can produce the product cheaper than anyone else. This allows you to sell at a lower price while maintaining the same margin. Amazon uses its massive scale to achieve this.
4. Intangible Assets: This includes brands and regulatory licenses. If you are the only company FDA approved to sell a specific drug, you have a government-enforced moat.

You do not start with a moat. You start with a shovel.

In the early days, your only advantage is speed and a unique insight. You must use that temporary window to dig the moat. You use your speed to acquire enough users to kickstart a network effect. You use your insight to embed your product deeply into the customer’s workflow to create switching costs.

If you stop digging to celebrate your early revenue, the water never fills the trench. The competitors will eventually cross the field.

Investors often evaluate moats by their width and depth.

• Width: How many different avenues of attack does it cover? Does it stop pricing wars? Does it stop feature cloning?
• Depth: How much money would a competitor have to burn to cross it?

If Uber wanted to cross Google’s search moat, they would have to spend billions and take decades. That is a wide and deep moat. If a competitor can clone your business with $100,000 and three months of dev time, you have a puddle, not a moat.