Want to build an empire? Get Moat-ivated
Recently I read something involving Warren Buffet’s investment philosophy.
He envisions every company that he invests in as a castle, surrounded by a moat. To judge the success of the company, the main parameter he looks for is if the moat has gotten bigger every year.
What does this mean? To put it simply: defensibility.
A castle with a bigger moat is less likely to be destroyed. Warren Buffet and his partner Charlie Munger have been in the investment game long enough to know that although many good companies pop up, only the great ones can withstand the test of time. You could probably say the same thing about great athletes too. And just like how great athletes must defend their records, great companies must defend their position in the market.
Buffet even goes on to say that annual “moat growth” is more important than annual profit growth. After all, profits can go up and down depending on various circumstances, but if you can make sure you’re not going anywhere, then you’ll be alright.
Okay okay, yeah I get it. This is pretty much business class 101 right? Porter’s 5 forces and all that. Create barriers of entry for your competition and make it hard for them to mess your situation up. Well, that’s half of it.
It’s easy to think of defensibility and immediately think of competitors. In fact, you probably should. But it’s more than just that. You need to think of both your competitors and your customers.
Your customers have to “stick” to you. After all the thing about disruption is that you don’t see it coming. It’s difficult to predict all the moves your competitors can do to beat you. Many times companies get disrupted because of something completely unexpected. Even if you are paying attention to everything, competitors aren’t under your control. However, keeping your customers is.
In my mind the formula for a growing your moat is simple: Increase your barrier of entry for competitors + increase your barrier of exit for customers.
Doing just one will probably keep you around for a while, but you need both to cement a legacy.
A good example of this is Amazon, a company that for a long period didn’t record profits, simply because it was shelling all that money back into it’s moat. And damn, do they have a massive moat. So how’d they build it?
Well, they moved quickly to be seen as the cheapest provider in almost every product category, and because of no physical locations they were able to spend money on establishing warehouses all over country, giving them a huge logistical advantage. Suddenly, you’ve got a company that’s seen as the cheapest provider of anything and can get it to you the fastest.
They not only introduced barriers of entry for competitors (setting up the warehouses) but they also created a strong barrier of exit for their customers (being seen as the cheapest and fastest provider of anything). And they didn’t stop there, they created greater exit barriers of exit for their users by providing amazing customer service, a trustworthy product review system, a subscription service with free 2 day delivery, and one of the fastest checkout systems in the game — just to name some.
The interesting situation that ends up happening is that these barriers of exit for the customer inherently start to become barriers of entry for the competitor, because people have limits on time and attention.
Netflix pumping out high quality exclusive content makes people not want to leave. But it also makes them less likely to sign up for other on demand streaming services, because most people don’t want to pay for more subscriptions. Making it hard for newcomers to even get a chance unless they really switch things up.
When building a company, it’s easy to get caught up in profits and growth (in fact these are probably your two biggest KPI’s). But keep in mind that there were probably thousands of other companies that had better profits and growth than Amazon for it’s first 10 years. However, there’s not many companies that are on Amazons tier now.
Buffet and Munger’s track record in investing shows that not only do they really look for people building big moats, but that building big moats works. In fact, it’s pretty hard to find an “empire” company that doesn’t have a pretty big moat. You could argue that having a lot of users or having a lot of money is the moat for a lot of these companies. But there’s plenty of companies who’ve had both and still lost.
So take some time to measure your moat, which isn’t as easy to do I’ll admit. You’ll need to list out all the barriers of entry your competitors have and all the barriers of exist you users have. Then find a way to measure the strength of each. This gets very contextual so it’s hard to define how to measure every barrier. But asking questions like “What would it take for someone to do what we’re doing?” and “What’s going to keep our customer from leaving if (insert doomsday scenario here) happens” is a good place to start.
In your early phases it’s gonna look more like a puddle, in fact you might not even have a moat, maybe just a little dug up trench. But you should still measure it. Because what you measure is more likely to grow.
And if you’re looking to build an empire, you’re going to need one big ass moat.