Misuse of Moats
I think that the word ‘moat’ is probably the most abused term in the world of investing. All thanks to the GOAT investor Warren Buffett who said that they like to invest in “businesses with a wide and long-lasting moat around it, protecting a terrific economic castle.” Now, venture funds ask startups “what’s your moat?” and founders are forced to give make-believe answers.
Berkshire invests in businesses, that have been around for decades and are likely to be around for decades, and claims that their holding period is forever. VCs invest in startups that haven’t been around for 5 years, might not be around in the next 5 years, and want to exit in 5 years. Make it make sense!
But jokes aside, I’ll share a few points that we need to be mindful about when discussing moats.
You Can’t Build Moats
I’ve often heard founders say “this will be our moat”. The most popular assertions are “proprietary data”, “better tech and product”, “network effects”, “personalisation”. Partly, I think we investors are to blame for this, because of how frequently we ask this to founders.
However, I have a few problems with the above framing of moats:
- The things that are often mentioned as moats – any equally competent competitor could also build them, and there are many such teams building similar businesses without much proven differentiation.
- You can’t build moats prospectively or predict what will be the moat. Instead, they are an outcome – an accumulation of all the business decisions that you have taken, that compound over time, and hence are evident only in hindsight.
- This also means that moats aren’t one or two parts of your business. It’s the sum total of everything that you have done, across product, technology, supply chain, internal operations, distribution, and economics, because of which your competitors simply can’t do what you can.
Risk of Disruption
I’m not old enough to know what businesses were like 100 or even 50 years ago but my guess is that they were much harder to build, and much harder to scale, which also meant that they were much harder to disrupt. Barriers to entry were high and market structures were stable so if you were able to build moats, there was a good chance you could sustain them.
But today, I think two factors have completely changed this. First is technology, and now increasingly, AI. Second is the availability of capital. Given sufficient technical capabilities and armed with enough capital, most businesses can be disrupted. Add to that, entry barriers are constantly going down, and markets are becoming increasingly dynamic.
Now, moats are an outcome of every decision taken by the business, and are spread across the entire business. And in order to sustain moats, businesses must continuously commit to the exact same things.
But if I were to invert this, moats can also become the prison that restricts the businesses from innovating or adapting to newer market trends. Because you’ve committed all your time and energy to a particular way of doing things, it’s nearly impossible to make any fundamental changes. Your greatest advantage can become your biggest vulnerability.
With startups, we’ve started to use ‘moats’ as the catch-all term to describe what makes you better than the others. We could just reframe it slightly to what I think any investor is trying to figure out (and how I think any founder can respond).
- What are your unique perspectives and insights about the market?
- What’s your hypothesis about how the market will evolve and what will work?
- What have you done to validate that hypothesis or what are your findings?
- How are you building your product and distribution based on that?
- How well does your competence align to build what you’re building?
Ultimately, startups exist to disrupt existing markets and create new ones – if you do that, the moat will build itself.