Moats are what create business success. What they are? Read on…

1. A Dozen Things I’ve Learned
from Charlie Munger about
Moats
Tren
Griffin
1.
“We
have
to
have
a
business
with
some
inherent
characteristics
that
give
it
a
durable
competitive
advantage.”
Professor
Michael
Porter
calls
barriers
to
market
entry
that
a
business
may
have
a
“sustainable
competitive
advantage.”
Warren
Buffett
and
Charlie
Munger
call
them
a
“moat.”
The
two
terms
are
essentially
identical.
Buffett
puts
it
this
way:
“The
key
to
investing
is
not
assessing
how
much
an
industry
is
going
to
affect
society,
or
how
much
it
will
grow,
but
rather
determining
the
competitive
advantage
of
any
given
company
and,
above
all,
the
durability
of
that
advantage.
The
products
or
services
that
have
wide,
sustainable
moats
around
them
are
the
ones
that
deliver
rewards
to
investors.”
A
complete
discussion
about
the
nature
of
moats
can’t
be
done
well
in
a
~3,000
word
blog
post
since
it
is
one
of
the
most
complex
topics
in
the
business
world.
For
this
reason,
in
my
book
on
Charlie
Munger
I
put
the
material
on
moats
in
an
appendix
since
I
feared
readers
would
bog
down
and
not
focus
on
the
more
important
points
such
as
making
investment
and
other
decisions
in
life.
But
the
complexity
of
the
topic
does
not
change
the
fact
that
to
be
a
“know-­‐something”
investor
you
must
understand
moats.
Even
the
fate
of
the
smallest
business
like
a
bakery
or
shoe
store
will
be
determined
by
whether
they
can
create
some
form
of
moat.
The
small
business
person
may
not
now
what
a
moat
is
called
but
the
great
ones
know
that
they
must
generate
barriers
to
entry
to
create
a
profit.
The
underlying
principle
involved
in
moat
creation
and
maintenance
is
simple:
if
you
have
too
much
supply
of
a
good
or
service,
price
will
drop
to
a
point
where
there
is
no
long-­‐term
industry
profit
above
the
company’s
cost
of
capital.
Michael
Mauboussin,
in
what
is
arguably
the
best
essay
ever
written
on
moats
put
it
this
way,
“Companies
generating
high
economic
returns
will
attract
competitors
willing
to
take
a
lesser,
albeit
still
attractive
return,
which
will
drive
aggregate
industry
returns
to
opportunity
cost
of
capital.”
The
best
test
of
whether
a
moat
exists
is
quantitative,
even
though
the
factors
that
create
it
are
mostly
qualitative.
If
a
business
has
not
earned
returns
on
capital
that
substantially
exceed
the
opportunity
cost
of
capital
for
a
period
of
years,
it
does
not
have
a
moat.

2. If
a
business
must
hold
a
prayer
meeting
to
raise
prices
it
does
not
have
a
moat.
A
business
may
have
factors
that
may
create
a
moat
in
the
future,
but
the
best
test
for
a
moat
is
in
the
end
mathematical.
The
five
primary
elements
that
can
help
create
a
moat
are
as
follows:
1. Supply-­‐Side
Economies
of
Scale
and
Scope;
2. Demand-­‐side
Economies
of
Scale
(Network
Effects);
3. Brand;
4. Regulation;
and
5. Patents
and
Intellectual
Property.
Each
of
these
five
elements
is
worthy
of
an
entire
blog
post
or
even
a
book.
These
elements
and
the
phenomenon
they
create
are
all
interrelated,
constantly
in
flux
and
when
working
together
in
a
lollapalooza
fashion
often
create
nonlinear
positive
and
negative
changes.
For
me,
questions
related
to
the
creation,
maintenance
and
destruction
of
moats
are
the
most
fascinating
and
challenging
aspects
of
the
business
world.
There
are
no
precise
formulas
or
recipes
that
govern
moats
but
there
is
enough
commonality
that
you
can
get
better
at
understanding
moats
over
time.
2.
“We’re
trying
to
buy
businesses
with
sustainable
competitive
advantages
at
a
low
–
or
even
a
fair
price.”
“Everyone
has
the
idea
of
owning
good
companies.
The
problem
is
that
they
have
high
prices
in
relations
to
assets
and
earnings,
and
that
takes
all
of
the
fun
out
of
the
game.
If
all
you
needed
to
do
is
to
figure
out
what
company
is
better
than
others,
everyone
would
make
a
lot
of
money.
But
that
is
not
the
case.”
Buying
a
business
with
a
moat
is
a
necessary
but
not
a
sufficient
condition
for
achieving
financial
success
in
a
business.
What
Charlie
Munger
is
saying
in
these
sentences
is
that
if
you
pay
too
much
for
a
moat
you
will
not
find
success.
No
one
makes
this
point
better
than
Howard
Marks
who
writes:
“Superior
investors
know
–
and
buy
–
when
the
price
of
something
is
lower
than
it
should
be…
most
investors
think
quality,
as
opposed
to
price,
is
the
determinant
of
whether
something’s
risky.
But
high-­‐quality
assets
can
be
risky,
and
low-­‐quality
assets
can
be
safe.
It’s
just
a
matter
of
the
price
paid
for
them.”
Some
people
have
this
idea
that
value
investing
is
only
about
buying
cheap
assets.
The
reality
is
that
many
assets
are
cheap
for
good
reason.
Genuine
value
investing
is
about
buying
assets
at
a
substantial
discount
to
their
value.
This
is
why
Charlie
Munger
says
that:
“All
intelligent
investing
is
value
investing.”

3. What
he
means
is:
is
there
any
type
of
investing
whether
the
objective
is
to
pay
more
than
an
asset
is
worth?
There
are
some
assets
for
which
an
intrinsic
value
can’t
be
computed,
but
that
is
a
different
question
than
whether
an
asset
should
be
purchased
at
a
discount
to
its
value.
Buffett
writes:
“The
very
term
‘value
investing’
is
redundant.
What
is
‘investing’
if
it
is
not
the
act
of
seeking
value
at
least
sufficient
to
justify
the
amount
paid?
Consciously
paying
more
for
a
stock
than
its
calculated
value
—
in
the
hope
that
it
can
soon
be
sold
for
a
still-­‐higher
price
—
should
be
labeled
speculation.”
3.
“You
basically
want
me
to
explain
to
you
a
difficult
subject
of
identifying
moats.
It
reminds
me
of
a
story.
One
man
came
to
Mozart
and
asked
him
how
to
write
a
symphony.
Mozart
replied,
“You
are
too
young
to
write
a
symphony.”
The
man
said,
“You
were
writing
symphonies
when
you
were
10
years
of
age,
and
I
am
21.”
Mozart
said,
“Yes,
but
I
didn’t
run
around
asking
people
how
to
do
it.”
“We
buy
barriers.
Building
them
is
tough…
Our
great
brands
aren’t
anything
we’ve
created.
We’ve
bought
them.
If
you’re
buying
something
at
a
huge
discount
to
its
replacement
value
and
it
is
hard
to
replace,
you
have
a
big
advantage.
One
competitor
is
enough
to
ruin
a
business
running
on
small
margins.”
While
there
is
no
formula
or
recipe
for
creating
a
moat
there
are
many
common
principles
that
can
be
used
in
trying
to
create
or
identify
one.
For
example,
Munger
has
said:
“In
some
businesses,
the
very
nature
of
things
cascades
toward
the
overwhelming
dominance
of
one
firm.
It
tends
to
cascade
to
a
winner
take
all
result.
”
On
another
occasion
he
said:
“Do
you
know
what
it
would
cost
to
replace
Burlington
Northern
today?
We
are
not
going
to
build
another
transcontinental.”
It
is
important
to
note
that
there
is
a
world
of
difference
between
creating
a
new
moat
than
buying
an
existing
one.
For
example,
the
venture
capital
business
is
fundamentally
about
building
moats
and
the
value
investing
discipline,
as
practiced
by
Munger
and
Buffett,
is
instead
about
buying
existing
moats
at
a
discount
to
the
intrinsic
value
of
the
business.
4.
“The
only
duty
of
corporate
executive
is
to
widen
the
moat.
We
must
make
it
wider.
Every
day
is
to
widen
the
moat.
We
gave
you
a
competitive
advantage,
and
you
must
leave
us
the
moat.
There
are
times
when
it’s
too
tough.
But
your
duty
should
be
to
widen
the
moat.
I
can
see
instance
after
instance
where
that
isn’t
what
people
do
in
business.
One
must
keep
their
eye
on
the
ball
of
widening
the
moat,
to
be
a
steward
of
the
competitive
advantage
that
came
to
you.”
What
Charlie
Munger
is
saying
in
these
sentences
is
that
operational
excellence
in
running
a
business
is
very
important,
but
the
factors
that
maintain
the
barriers
to
entry
of
the
business
must
also
receive
proper
attention
by
management.
For
example,
if
the
moat
of
a
business
is
based
on
network
effects
or
intellectual
property
those
factors
can’t
be
ignored.

4.
Sometimes
playing
defense
is
needed
in
whole
or
in
part,
as
was
the
case
when
Facebook
bought
several
potential
moat
destroyers.
The
Instagram,
Oculus
and
WhatsApp
acquisitions
were
in
no
small
part
designed
to
widen
the
existing
Facebook
moat.
Of
course,
the
companies
were
bought
to
create
new
moats
too,
so
in
that
sense
they
served
two
purposes
(i.e.,
the
acquisitions
served
both
offensive
and
defensive
purposes
for
Facebook).
Startups
potentially
have
an
asymmetrical
advantage
since
often
they
are
bought
by
incumbents
just
for
defensive
reasons
(i.e.,
sometimes
in
an
acquisition
only
consumers
benefit
since
the
new
service
or
good
is
all,
or
nearly
all,
consumer
surplus).
5.
“How
do
you
compete
against
a
true
fanatic?
You
can
only
try
to
build
the
best
possible
moat
and
continuously
attempt
to
widen
it.”
The
job
of
a
businessperson
is
to
try
to
create
product
or
service
which
are
sufficiently
unique
that
constraints
are
placed
on
other
companies
who
desire
to
provide
a
competing
supply
of
those
goods
or
services.
For
this
reason
moat
creation
and
maintenance
is
a
key
part
of
the
strategy
of
any
business.
What
this
means
is
that
the
essential
task
of
anyone
involved
in
establishing
a
strategy
for
a
business
is
defining
how
a
business
can
be
unique.
Creating
a
business
strategy
is
fundamentally
about
making
choices.
It
is
not
just
what
you
do,
but
what
you
choose
not
to
do,
that
defines
an
effective
strategy.
Professor
Michael
Porter
argues
that
doing
what
everyone
must
do
in
a
business
is
operational
effectiveness
and
not
strategy.
The
people
who
most
often
create
unique
compelling
offerings
for
customers
are
true
fanatics.
Jim
Sinegal
of
Costco
is
just
such
a
fanatic
which
is
why
Charlie
Munger
serves
on
their
board.
Going
down
the
list
of
Berkshire
CEOs
reveals
a
long
list
of
fanatics.
6.
“Frequently,
you’ll
look
at
a
business
having
fabulous
results.
And
the
question
is,
‘How
long
can
this
continue?’
Well,
there’s
only
one
way
I
know
to
answer
that.
And
that’s
to
think
about
why
the
results
are
occurring
now
–
and
then
to
figure
out
what
could
cause
those
results
to
stop
occurring.”
This
set
of
sentences
is
an
example
of
Charlie
Munger
applying
his
inversion
approach.
He
believes
that
when
you
have
a
hard
problem
to
solve
the
best
solution
often
appears
when
you
invert
the
problem.
For
example,
Munger
applies
the
inversion
process
to
moat
analysis.
Instead
of
just
looking
at
why
a
moat
exists
or
can
be
made
stronger,
he
is
saying
you
should
think
about
why
it
may
weaken.
He
is
looking
for
sources
of
unique
insight
that
might
have
been
missed
by
others
who
may
be
too
optimistic.
Not
being
too
optimistic
is
consistent
with
his
personality.
Munger
has
called
himself
a
“cheerful
pessimist.”

5. Over
time
the
forces
of
competitive
destruction
will
inevitably
weaken
any
moat.
Munger
has
said:
“It
is
a
rare
business
that
doesn’t
have
a
way
worse
future
than
a
past.”
“Capitalism
is
a
pretty
brutal
place.”
“Over
the
very
long
term,
history
shows
that
the
chances
of
any
business
surviving
in
a
manner
agreeable
to
a
company’s
owners
are
slim
at
best.”
Bill
Gates
describes
what
Berkshire
is
looking
for
in
a
business
as
follows:
“[they]
talk
about
looking
for
a
company’s
moat
—
its
competitive
advantage
—
and
whether
the
moat
is
shrinking
or
growing.”
7.
“Kellogg’s
and
Campbell’s
moats
have
also
shrunk
due
to
the
increased
buying
power
of
supermarkets
and
companies
like
Wal-­‐Mart.
The
muscle
power
of
Wal-­‐
Mart
and
Costco
has
increased
dramatically.”
Wholesale
transfer
pricing
power,
also
sometimes
called
supplier
bargaining
power
(e.g.,
in
the
Michael
Porter
five
forces
model)
is
a
potential
destroyer
of
moats.
Understanding
who
has
pricing
power
in
a
value
chain
is
a
critical
task
for
any
manager.
As
an
example
of
a
moat
being
attacked
in
this
way,
the
venture
capitalist
Chris
Dixon
wrote
once
about
a
chain
of
events
in
the
gaming
industry
:
“In
Porter’s
framework,
Zynga’s
strategic
weakness
is
extreme
supplier
concentration
–
they
get
almost
all
their
traffic
from
Facebook.
It
is
in
Facebook’s
economic
interest
to
extract
most
of
Zynga’s
profits,
leaving
them
just
enough
to
keep
investing
in
games
and
advertising.”
As
another
example,
most
every
restaurant
which
does
not
own
its
building
faces
this
same
wholesale
transfer
pricing
problem.
If
you
have
an
exclusive
supplier
of
a
necessary
input,
that
supplier
controls
your
profits.
It
is
wise
to
have
multiple
suppliers
of
any
good
or
service,
at
least
potentially.
8.
“What
happened
to
Kodak
is
a
natural
outcome
of
competitive
capitalism.”
“The
perfect
example
of
Darwinism
is
what
technology
has
done
to
businesses.
When
someone
takes
their
existing
business
and
tries
to
transform
it
into
something
else—they
fail.
In
technology
that
is
often
the
case.
Look
at
Kodak:
it
was
the
dominant
imaging
company
in
the
world.
They
did
fabulously
during
the
great
depression,
but
then
wiped
out
the
shareholders
because
of
technological
change.
Look
at
General
Motors
Company,
which
was
the
most
important
company
in
the
world
when
I
was
young.
It
wiped
out
its
shareholders.
How
do
you
start
as
a
dominant
auto
company
in
the
world
with
the
other
two
competitors
not
even
close,
and
end
up
wiping
out
your
shareholders?
It’s
very
Darwinian—it’s
tough
out
there.
Technological
change
is
one
of
the
toughest
things.”
I
don’t
know
of
any
business
in
today’s
business
world
that
does
not
face
significant
disruptive
threats.
None.
It
is
brutally
competitive
to
be
involved
any
business
today.
Do
some
businesses
have
moats
that
make
their
lines
of
business
relatively
more
profitable?
Sure.
But
I
can’t
think
of
any
business
which
is
not
under
attack
right
now.

6. When
I
say
every
business
is
competitive
in
today’s
world
I
mean
every
business.
Life
as
the
owner
of
a
sandwich
shop,
a
food
processor,
marketing
consultancy,
etc.
is
inevitably
tough.
Pricing
power
in
the
business
world
today
is
rarer
than
a
Dodo
bird.
Technology
businesses
present
a
special
case
when
it
comes
to
moats
since
disruptive
change
is
much
more
likely
to
be
nonlinear.
Businesses
in
the
technology
sector
that
seem
relatively
solid
can
disappear
in
the
blink
of
an
eye.
The
factors
like
network
effects
that
can
create
startling
success
for
a
technology
company
can
be
just
as
powerful
on
the
way
down
as
they
were
the
way
up.
9.
“The
perfectly
fabulous
economics
of
this
[newspaper]
business
could
become
grievously
impaired.”
The
newspaper
business
once
had
a
strong
moat
created
by
economies
of
scale
inherent
in
huge
printing
plants
and
large
distribution
networks
needed
for
physical
newspapers.
The
Internet
has
caused
the
moats
of
newspapers
to
quickly
atrophy,
which
is
problematic
for
owners
and
society
as
a
whole
given
that
the
news
itself
is
what
is
called
a
“public
good”
(i.e.,
non-­‐rival
and
non-­‐excludable).
Charlie
Munger
has
lamented
the
decline
of
newspapers:
“It’s
not
good
for
the
country.
We’re
losing
something.”
Buffett
has
said
it
“blows
your
mind”
how
quickly
the
newspaper
industry
has
declined.
The
way
commentators
on
the
financial
prospects
of
newspapers
ignore
the
public
good
problems
is
amazing
really.
Increasing
something
like
quality
does
not
fix
a
public
good
problem.
Without
some
scarcity/a
moat
there
will
be
no
ability
on
the
part
of
newspapers
to
generate
a
profit.
Solutions
to
journalism
business
model
problems
are
likely
to
include
philanthropy
as
is
the
case
with
other
public
goods.
10.“Network
TV
[in
its
heyday,]
anyone
could
run
and
do
well.
If
Tom
Murphy
is
running
it,
you’d
do
very
well,
but
even
your
idiot
nephew
could
do
well.”
Some
moats
are
so
strong
that
even
a
weak
management
teams
can
prosper
running
the
business.
The
broadcast
television
moat
is
not
what
it
once
was
given
the
rise
of
things
like
over
the
top
viewing.
But
at
one
time
television
had
a
bullet-­‐proof
moat.
Buffett
believes:
“When
a
management
with
a
reputation
for
brilliance
tackles
a
business
with
a
reputation
for
bad
economics,
it
is
the
reputation
of
the
business
that
remains
intact.”
Munger
certainly
wants
a
business
in
which
he
invests
to
be
run
by
capable
and
trustworthy
managers.
Operational
excellence
is
always
desired.
But
having
a
moat
is
a
protection
against
a
poor
manager
running
a
business
into
the
ground.
Buffett
said
once:
“Buy
into
a
business
that’s
doing
so
well
an
idiot
could
run
it,
because
sooner
or
later,
one
will.”

7. 11.
“I
think
it’s
dangerous
to
rely
on
special
talents
—
it’s
better
to
own
lots
of
monopolistic
businesses
with
unregulated
prices.
But
that’s
not
the
world
today.”
In
these
sentences
Charlie
Munger
uses
a
term
that
Peter
Thiel
likes
to
use
when
referring
to
a
moat:
“monopoly”.
While
it
is
certainly
profitable
to
own
an
unregulated
monopoly,
the
number
of
businesses
today
that
have
moats
which
can
be
considered
a
monopoly
is
vanishingly
small.
For
this
reason
I
think
Peter
Thiel
takes
the
monopoly
point
too
far.
The
word
monopoly
is
loaded
and
carries
too
much
baggage
to
be
useful.
The
reality
is
that
the
nature
of
moats
is
not
binary.
Moats
come
in
all
varieties,
from
strong
to
weak.
They
are
always
in
flux
and
vary
on
multiple
dimensions.
For
example,
some
big
moats
are
more
brittle
than
others.
Some
moats
protect
valuable
market
segments
and
some
do
not.
In
other
words,
moats
can
be
classified
along
a
spectrum
from
strong
to
weak,
valuable
to
non
valuable
and
from
big
to
small.
12.
“The
informational
advantage
of
brands
is
hard
to
beat.
And
your
advantage
of
scale
can
be
an
informational
advantage.
If
I
go
to
some
remote
place,
I
may
see
Wrigley
chewing
gum
alongside
Glotz’s
chewing
gum.
Well,
I
know
that
Wrigley
is
a
satisfactory
product,
whereas
I
don’t
know
anything
about
Glotz’s.
So
if
one
is
$.40
and
the
other
is
$.30,
am
I
going
to
take
something
I
don’t
know
and
put
it
in
my
mouth
–
which
is
a
pretty
personal
place,
after
all
–
for
a
lousy
dime?
So,
in
effect,
Wrigley,
simply
by
being
so
well-­‐known,
has
advantages
of
scale
–
what
you
might
call
an
informational
advantage.
Everyone
is
influenced
by
what
others
do
and
approve.”
“Another
advantage
of
scale
comes
from
psychology.
The
psychologists
use
the
term
‘social
proof’.
We
are
all
influenced
–
subconsciously
and
to
some
extent
consciously
–
by
what
we
see
others
do
and
approve.
Therefore,
if
everybody’s
buying
something,
we
think
it’s
better.
We
don’t
like
to
be
the
one
guy
who’s
out
of
step.
Again,
some
of
this
is
at
a
subconscious
level
and
some
of
it
isn’t.
Sometimes,
we
consciously
and
rationally
think,
‘Gee,
I
don’t
know
much
about
this.
They
know
more
than
I
do.
Therefore,
why
shouldn’t
I
follow
them?’
All
told,
your
advantages
can
add
up
to
one
tough
moat.”
The
most
important
point
made
in
these
sentences
by
Charlie
Munger
is
that
the
great
moats
which
exist
in
the
world
tend
to
have
an
aggregate
value
that
is
more
than
the
sum
of
the
parts.
Munger
calls
this
a
“lollapalooza”
outcome.
Others
may
refer
to
it
as
synergy.
As
an
example,
many
moats
in
the
technology
business
are
based
on
what
Munger
calls
an
informational
advantage,
but
there
can
be
many
other
factors
like
economies
of
scale
or
intellectual
property
that
feed
back
on
each
other
to
create
and
strengthen
the
moat.

8. I
am
at
~3,400
words
in
this
post
and
if
you
are
still
reading
the
probability
is
good
that
you
understand
or
soon
will
understand
this
critical
aspect
of
investing
called
“moats.”
The
opportunities
to
learn
never
end.
I
think
is
the
best
game
on
Earth
and
that
fact
explains
why
Munger
and
Buffett
love
what
they
do
so
much
that
they
plan
to
continue
to
be
investors
as
long
as
they
are
physiologically
able
to
do
so.
Here’s
Buffett
to
finish
this
post
off:
“I
will
say
this
about
investing:
Everything
you
do
earn
is
cumulative.
That
doesn’t
mean
that
industries
stay
good
forever,
or
businesses
stay
good
forever,
but
in
learning
to
think
about
business
models,
what
I
learned
at
20
is
useful
to
me
now.
What
I
learned
at
25
is
useful
to
me
now.
It’s
like
physics.
There
are
underlying
principles,
but
now
they’re
doing
all
kinds
of
things
with
physics
they
weren’t
doing
50
years
ago.
But
if
you’ve
got
the
principles,
if
you
know
what
makes
a
good
business,
if
you
know
what
makes
a
good
manager,
if
you
know
what
makes
a
good
product,
and
you
learn
that
in
one
business,
there
is
some
transference
to
other
businesses.”