Do people over-index on 'moats'
I think the term 'moat' has been really excessively used in the past years. Everything suddenly has to be "mission critical" with a clear and defensible moat.
You know what ... With this in mind I think I tend to sometimes overcomplicate things and get too academic in my approach. I've seen so many markets where it is not super clear what the "strong" moats would be. It is just a bunch of companies producing a product that other players could produce equally well. Historically though, there emerged 3-4 players which control now most of the market.
Do we then say, well the moat is brand? Or the moat are the customer-ties? Technically, any deep-pocketed larger company could replicate the product/production ... but they are not. Likely because the business-case is not good enough entering the market as the next in line.
I don't know ... it just trips me up that every business should have a patent, super high/lock-in switching costs, etc. I think the majority of good business would have never been created if a PE/corporate strategy person would have done a complex analysis and model to make that decisions.
Well, looking at how quickly some saas software moats disappeared - you’re not wrong.
I agree both private and public investors over-index on moats and don't really understand the deeper meaning behind them. Airports have moats because opening up another airport requires lot of regulatory approvals, capex budget, and experience that many other companies do not possess. But Mcdonalds doesnt have a moat, when consumers are hungry Mcdonalds is one of the options they consider but will be fine with alternatives. Uber is another one, it has strong network effects and integration with food delivery and transportation, but if you have capital there's nothing stopping you to create another app that could do the same as long as you could be competitive on pricing. Scale or brand name doesn't equal a moat; there has to be another ingredient that makes the company desirable or wanted. Just because a company has a moat doesn't make it a good investment if you overpay for that moat, and there aren't that many companies in the world that have a strong, everlasting moat.
You had me until the Uber example and everything after that.
First, economies of scale and branding are moats, just not necessarily the strongest ones typically. For branding, Coca Cola is the first example to come to mind (which should be a no brainer why no other soft drink can compete), while for economies of scale any mega cap business would do. Economies of scale makes fixed costs cheaper, which means smaller companies would be burning cash to compete at similar price levels. Yes, any well capitalized company could compete, if the only moat was capital/scale, but it wouldn’t make financial sense to do so in most cases, especially in industries that are growing slightly above GDP.
I think you severely understate Uber’s network effects lol. Lyft has been trying for years to truly compete against Uber but in the U.S., they only have around 20% market share, which is exactly because of Uber’s superior network effects. Uber’s new competitors are GOOGL and TSLA, yes, but those companies already have access to customers through their own network/brand, and can skip the driver network effects with AVs.
Uber for sure has a moat. There was an App in NYC that offered cheaper rides and more money for drivers a couple months bank, and Uber had their legal/political mafia dismantle it within a month.
Cab companies in cities outside out of NYC have been cooked. You even have yellow cabs on the Uber App. I’d say they definitely have a moat.
Ya agreeing with the other dude who replied to you , your uber example ain’t it. Few things.
First of all, it’s prob better to think about this stuff on a continuum of “how hard would it be for someone to replicate” instead of “no one could ever replicate vs someone could”. Technically, for 99% of businesses unless there is like a constrained resource no one else can use (either its finite or the government is pretending you), anything is replicable (eg with your airport example, i am not too well versed on airport regulations but if you had a ton of capex and were flexible on location and very good at lobby, you could prob do, but A) it would be very hard and B) unlikely to work, but technically you could do).
But ya the biggest thing you’re missing here is network effect with your uber thing… uber is a good business because it’s better for riders for every additional driver that is on the platform, and better for drivers to have more riders on (and technically also better in some ways for riders to have more riders, since they provide reviews etc) such that sure, if you wanted to you could replicate Uber, but how do you get drivers to get on your app? And if you don’t have drivers, how do you get passengers ? And if you don’t have passengers, how do you get drivers ?
This works very similarly with dating apps. Many people don’t like hinge, and creating a dating app is presumably very easy to do from a technical capacity, and there are a ton out there, and yet , I’m willing to bet hinges share has been relatively consistent … how do you get dudes to go on a new app if no girls and girls to go on a new app if no guys etc
I do think, OP is on to something here tho at least in SaaS. It feels like in SaaS having a technical differentiation , especially with some earlier stage growthier asset should be more important , eg if you have some cool new software without a lot of customers and are thinking of growing it, how do you think it will be grow able unless you have some “secret sauce” that others cannot copy easily ? But it feels like today with AI etc, this is probably over blown . I don’t really have the answer for you since I think about this all the time, but I think this is why people tend to like systems of record generally speaking in that if you have some Hr tool that is a bit sleeker looking, why not just juice in a lot of S&M spend and then retain customers becusss it’s hard to switch (again I don’t really buy this, there’s actually probably more to network effects that could be interesting )
We can agree to disagree on Uber. In my view, Uber's network effect helps it create a strong competitive advantage, but its network effect came from subsidizing early users (both drivers and riders), and if you have enough capital to subsidize users, you could create a competing app with similar network effects. Traditional cabs held a monopoly due to city regulations limiting the number of cabs, but Uber managed to override local regulations, which makes Uber more vulnerable now, as new entrants won't deal with local bureaucracy that Uber dealt with in its early years. Switching isn't that hard for drivers or riders as long as the next app offers similar scale and pricing. What helped Uber succeed is that it was way more aggressive in dealing with competitors and regulators and had strong funding. In my opinion, Uber doesn't have a strong moat, but it does have a strong competitive advantage.
Lyft lost because they weren't as aggressive as Uber on growth, and VCs believed this would be a winner-takes-all market, which limited the capital available for Lyft.
This is maybe one of the most egregiously wrong comments on WSO that I have seen as most helpful. Uber is one of the first companies that come to mind when people discuss moats. I don't care how much capital you have; you are not going to gain Uber's network of users and service providers. The moat of all the tech super-apps such as Facebook and Uber is network effects, it's not the actual app itself, which is fairly easy to replicate functionality wise.
A well substantiated moat that results in genuine customer stickiness is invaluable.
The moat just needs to be real.
Everyone in the chain likes a moat. LPs, funds, founders. It is a shorthand signal for a legal quasi mono/duo/etc-polistic opportunity
No. Chris Hohn from TCI's focus is investing in businesses with a true moat as main motivator as is Mala Gaokar at Surgocap. They both have been done very well for themselves. What is truly hard to determine is who actually has a moat and what is marketting. Disagree with the above commentor regarding Uber heavily, they are a classic high moat business with network effects. Same for Meta / Facebook. The actual apps are not the real moat, it's a network effects business. Those investors have done very well for themselves in the markets. Focusing on moats as a key factor is something that is workable, though probably requires a more long-term view than other strategies as moat-focused investing usually (but not always) means paying up valuation wise.
So from a public markers perspective it is then, however, not identifying strong moats (everybody could do it, why should you get paid for it), but seeing something in businesses that other people are not seeing / underestimating (i.e., other people think the moat is not sustainable while you think it is).
This argument of course also holds for the private market then.
OP wrote:
Do we then say, well the moat is brand?
Or the moat are the customer-ties?
To me, and for the vast majority of entrepreneurs who will not end up being a hyperscaler, a moat mainly comes from an immovable proximity to the customer (either physically or virtually). But this moat only ensures you X% of market share, and the rest is how good you are: product, marketing, distribution.
From a real estate, physical world perspective, I think of that gelato stand that is next to the tourist ferry dock. Sure there are several other gelato stands within 1,000 feet of the dock, but that first one, and on a hot, sunny day is going to get customers. For most people, that gelato stand is a successful business that for generations will take care of their family. Location, location, location.
In the virtual world, proximity to the customer, I believe can come from owning domain names that represent the category. What comes to mind is Crypto .com. Sure there are many crypto companies sprouting up in a shady industry, but there’s only one Crypto .com so naturally you think that is a legit company because of the recognizability and rarity of the domain name. The company may or may not be the biggest company in the industry, but if you bootstrapped something like that company, you’re probably going to take care of your family for generations just because you can get at least X% market share. Legitimacy, legitimacy, legitimacy.
The beauty with this approach is new words and categories are being created all the time, and that means there will be opportunities for you to find them or purchase these domains. Once you own them, it’s yours.
The next step is to combine legitimacy with location (physical or virtual).
Other than that, it is a free for all, until you become a planet sized, hyperscaler.
This is how I see this crazy AI world using the lens of a real estate developer and physical and virtual world entrepreneur.
Your gelato stand example is (in my opinion) not a moat - it’s a competitive advantage. The moat is how you defend your competitive advantage.
For example if there is no physical reason (e.g. physical space, regulation/permitting, etc.) why another gelato stand can’t pop up next to you or even closer to the dock, then you have no moat and your competitive advantage is not sustainable.
Notice I gave a physical world example. Locations are finite. Notice I said the first one from the ferry dock. There are supply constraints. Even if there was room for two gelato stands, that is still a moat. Or three. Or four. Doesn’t matter to get X% market share.
Even if for some possible reason, a really small gelato stand was able to fit in right in front of my example gelato stand (someone got bribed). But only one. That is still a moat for Y% market share.
If you can support your family for generations with at least Y% market share, that is a great business.
I gave a virtual example as well. Your counterpoint is more virtual. I guess the extreme example in the physical world would be thousand gelato stand boats surrounding the ferry as it arrives. And gelato food trucks blocking your stand, who then leave when ferry closes. By the time the tourist reaches your stand they were asked if wanted to buy the same gelato 20 times. By then they already bought or want to get the heck out of there.
The main point of my post is while everyone is fixated on the multi billion dollar moats, there are many more smaller moats out there that can give you a great life for generations. In a world becoming hyper competitive and needing to raise billions just to compete in some instances, you have to think differently. I think lessons from the physical world could provide that twist.
Take a shot everytime they say something is “mission-critical”.
I think apple is a very weird case regarding moats. In the US, especially with the younger generations, it is considered odd to not have an iPhone. That being said, Apple does utilize a few tricks like making text messages green vs blue to signal you don't have an iPhone and create that feeling of fomo. With this (I could be wrong but in my experience) Apple doesn't do anything significantly crazy that justifies this hold they have on the US besides brand appeal and making the allusion that not having an iPhone is a social cost. Yes, Apple products fit an aesthetic, but I haven't seen anything else like this.
Then, you can compare this moat to a company like NVIDIA. A large reason NVIDIA has become so successful is that their software that they offer with GPUs was utilized before AI development for math calculations. From this, as AI developed and the need to do math calculations occurred, ppl/scientists/developers were already used to the software of NVIDIA GPUs, thus creating high switching costs and ppl sticking with NVIDIA GPUs.
It gets nauseating hearing people always talk about moats, but I think it's not really over-indexed. IMHO its pretty essential that you have some barrier that makes another person not want to borrow a ton of money and compete with you. Without a meaningful barrier, terminal value gets tough and most of the business value is usually in terminal value.
An earlier comment said McDonald's has no moat. I think it has a major moat which is that it picked off the best locations in every town across the US and much of the globe. Anyone who wants to open a competing franchise in their local area is starting off with the 2nd best spot or worse.
At least if we're being broad in defining moats, I'd say its not over indexed.
I am in LMM consumer where moats are never too strong or high quality because otherwise the businesses would be bigger with better margins.
But, I do think they're generally overrated because the company ends up priced accordingly, and then when the moat does break in an unexpected way, you're in a rough spot.
A good example is all the tech disruption caused by AI over the last 2 years. A lot of growthy stuff got crushed.
Klaviyo stock is probably my favorite example. Trading for 2.9x rev once you account for SBC. It's actually very high quality revenue as no better alternative exists, and the backend is incredibly hard to replicate. But...still beat up price wise....so if you overpaid for quality, you got fried.
People overabuse the word. There are very few businesses with moats. If you scale a business beyond its geographical location and the business will have a hard time competing in other regions, that's proof it has no moat and only regional competitive advantages.
Moats are very important. The distinction you want to be clear about, is this truly a moat in a world of AI? SaaS will tell you what was once moats, can evaporate quickly. SaaS is this first domino for AI, there will be other industries.
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