Let's talk about Moats
Everything you need to know (with examples)
1.0 Introduction
In business, I look for economic castles protected by unbreachable ‘moats’ - Warren Buffett.
If you’ve listened to Warren Buffett, chances are you’ve heard the word ‘moat’ more than a few times.
But what exactly does ‘ economic moat’ mean?
The simplest translation is:
An advantage that the business has over its competitors, and
The ability to maintain it over time.
Having a competitive advantage allows the company to not just be resilient and protected from its competition, but also maintain higher margins (often due to their pricing power), which leads to long-term value creation (if the capital is wisely allocated).
Markets are dynamic. Profits attract competition, and over time, most companies see their margins compress. Without a moat, high returns are temporary.
However, businesses with durable moats can generate above-average returns on capital for long periods. This makes them compounding machines and makes moats valuable for long-term investors.
2.0 The Key Sources of Economic Moats
So, how does a company create an economic moat? Here are the five sources:
2.1 High switching costs
Some companies offer a product or a service, and changing to another provider/supplier comes with a cost that outweighs the benefit.
Data storage (due to risk, complexity, and downtime involved in migration)
Operating systems (Windows, macOS - due to software compatibility, user familiarity, and integrated ecosystems)
Specific Software Solutions (Salesforce, SAP, Microsoft Office - due to deep integration into business processes, employee training, and data migration challenges)
2.2 Network effects
Certain companies become exponentially more useful as their user base grows, making it difficult for new competitors to gain traction.
Social media platforms (Facebook/Instagram, X, Reddit, LinkedIn)
Marketplaces (eBay, Amazon, Uber)
Credit card networks (Visa, Mastercard)
2.3 Cost advantages
This could take various forms, ultimately allowing the company to produce goods or services cheaper than its competitors, enabling lower prices or higher margins.
Process advantage - Unique, efficient processes can lower costs (Tesla)
Scale advantages - Larger companies (Walmart, McDonald’s) can buy inputs cheaper, distribute more efficiently, and spread fixed costs over more units (economies of scale)
Access to unique assets - This could be owning a low-cost mine or having a strategically located port or distribution centres (Amazon)
2.4 Efficient scale
Specific industries (like railroads, regional airports, utilities) often have high infrastructure costs, making it uneconomical for multiple competitors to build duplicate networks in the same region. The existing players effectively serve the entire market, deterring new entrants.
2.5 Intangible asset
Patent - Allowing the company to be a legal monopoly for some time. This is more common for companies in biotech/pharmaceuticals. It is an outcome of successful R&D efforts.
Regulatory Licenses/Approvals - Waste management companies need permits, and banks need licenses. Obtaining them is not easy.
Brand name - Strong brands (like Apple and Coca-Cola) foster customer loyalty and allow premium pricing. However, they’re built over time and result from exceptional customer satisfaction.
Understanding where moats come from is step one. Step two is learning how to measure and validate them.
3.0 Quantitative assessment
In my opinion, the quantitative assessment already gets a lot of attention and can be analyzed through various ratios:
Sustained high return on capital (shows efficient use of capital)
High and stable (or growing) gross and operating margin (indicates pricing power and/or cost control)
Consistent Free Cash Flow generation (signals financial health and ability to reinvest)
Market share dominance/stability (reflects competitive strength)
These metrics can be compared to industry competitors over 5-10 years to assess durability.
But this isn’t enough. Otherwise, picking companies with a moat could be automated.
4.0 Qualitative assessment
Arguably more critical is the qualitative assessment, which comes down to understanding four topics:
The business: How does the company make money? What is its value proposition?
The industry: What are the competitive dynamics? Are the barriers to entry high?
The customer: Why do customers choose this company? Are there high switching costs? How strong is the brand loyalty?
The quality of the management: Does management actively work to widen the moat and allocate capital effectively?
Here’s a great video that’s worth watching.
5.0 A word of caution
Moats aren’t permanent. Technology, changing consumer preferences, or poor management decisions can erode even the widest moats. Kodak and Blockbuster are great examples of companies being disrupted by technological shifts.
Determining a moat's actual width and durability requires deep analysis and judgment.
Lastly, moats aren’t an excuse to ignore valuation. Even a great company with a wide moat can be a poor investment if the price is too high.
6.0 Bonus: Nine companies with moats:
Asana (Networking effects, high switching costs) - Asana’s project management tools become more valuable as teams collaborate within the platform. The integration into daily workflows makes transitioning to other tools disruptive, enhancing customer retention.
Palantir Technologies (Proprietary tech, government contracts) - The specialized platforms are embedded in critical government and commercial operations. Its long-term contracts and unique capabilities create high barriers for competitors.
Snowflake (Networking effects, high switching costs) - The cloud data platform becomes deeply integrated into customers’ operations, making it costly and complex to switch providers. As more organizations adopt Snowflake, the value of its data-sharing ecosystem increases, reinforcing its competitive position.
Cloudflare (Scale advantages, network effects) - The expansive global network improves performance and security for its clients. As more websites use its services, the network becomes more robust, attracting additional customers and creating a self-reinforcing cycle
Unity (Ecosystem lock-in, high switching costs) - Unity’s game development platform is widely adopted, and developers invest significant time learning and building with its ecosystem. Switching to a different platform would require substantial effort, deterring migration.
UpWork (Network effects, brand recognition) - UpWork’s marketplace connects freelancers with clients globally. As more users join and use the platform, it becomes increasingly valuable to service providers and seekers.
UIPath (High switching costs, proprietary technology) - UIPath specializes in robotic process automation (“RPA“), enabling businesses to automate repetitive tasks. Its platform becomes deeply embedded in clients’ operations, making it challenging to replace.
Toast (Integrated platform, high switching costs) - The company provides point-of-sale and management systems tailored for restaurants. Its comprehensive suite of tools becomes deeply integrated into daily operations, making transitions to other systems costly and complex.
Coupang (logistics infrastructure) - Often described as the “Amazon of South Korea”, the company has built an extensive logistics network, enabling same-day or next-day delivery. This infrastructure creates high entry barriers for competitors.
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