The Playbook · Business Analysis
The Five Kinds of Economic Moats, With Examples
High profits attract competition the way honey attracts bears. A moat is whatever keeps the bears out — and there are only about five kinds.
Buffett's image is a castle — the business — surrounded by a moat that widens every year. The castle's treasure is its return on invested capital. In a competitive economy, unusually high returns are an open invitation for rivals to attack, and most castles eventually fall. The rare, durable exceptions are what he wants to own.
Nearly every real moat is a version of one of five structures.
1. Brands that command a price premium
The test of a consumer brand moat is pricing power, not fame. Coca-Cola and See's Candies — two of Buffett's signature holdings — can charge more than functionally similar products year after year because the brand itself is part of what the customer buys. A famous brand that cannot raise prices without losing volume is marketing, not a moat.
2. Switching costs
When leaving a product is expensive, risky, or exhausting, customers stay even when a competitor is somewhat better or cheaper. Bank accounts, enterprise software, and railroad customers with plants built along one carrier's track all exhibit this. The revenue that comes from customers who would rather not bother switching is some of the most durable revenue in the economy.
3. Network effects
Some products get better as more people use them: payment networks, marketplaces, exchanges. Each new participant makes the service more valuable to every existing participant, which makes displacing the leader progressively harder. American Express, a Berkshire holding since the 1960s, benefits from a version of this on both the cardholder and merchant sides.
4. Cost advantages
If a company can durably produce at lower cost than any rival — through scale, location, process, or a unique asset — it can match any competitor's price and still profit. GEICO's direct-selling model let it underprice agent-based insurers for decades. Scale-based cost moats are powerful but need watching: they hold only while the scale advantage holds.
5. Licenses, patents, and regulation
Some businesses are protected by permission: utility franchises, drug patents, airport slots, credit-rating accreditation. These moats can be extremely strong right up until the rules change — which is why they demand a closer watch on politics than the other four kinds.
How to test any claimed moat
- Pricing: has the company raised prices ahead of inflation without losing share?
- Returns: has return on invested capital stayed high through at least one full cycle?
- Attack history: have well-funded competitors tried and failed?
- Direction: is the moat widening or narrowing? A narrowing moat is a melting ice cube regardless of today's width.