Definition of economic moat: A specific and persistent advantage which a company holds over existing or potential new competitors.
What is an economic moat?
An economic moat is a metaphor for a trait, asset, or market position which is almost unassailable for competitors. You may see the term ‘economic moat’ in modern economics books.
This could take many forms:
- The ability to charge higher prices
- A lower cost base
- A more loyal consumer base
- Being subject to preferential laws and regulations
In all cases, the moat not only provides the business with a profitability advantage in the present, but this edge is also expected to last for the medium or long term.
An economic moat is an attractive characteristic for a business to have in the eyes of an investor. Value investors such as Warren Buffet have frequently referred to this quality when justifying an investment decision.
‘Economic moat’ is a layman term and is quite subjective by nature. Two people may disagree whether a company does or does not benefit from a moat.
As a result, you won’t find economic moats being quoted on Google Finance. However, you may see a reference to them in the reports of analysts, investors or other commentators.
Real examples of economic moats
Google Inc could have an economic moat in that its brand is synonymous with the action of using a search engine. It is widely regarded as the ‘default’ search engine in the minds of most consumers. This is a privileged position which severely hampers new search engine websites from gaining a foothold in the market.
Coca Cola may enjoy a similar moat in the sense that it is also seen as the ‘default’ soft drink choice in restaurants and bars. The market for soft drinks is dominated by several large conglomerates, but it’s a ‘Coke’ rather than a ‘Pepsi’, which is often ordered by many consumers almost without the consumer even thinking. What many companies wouldn’t give to hold the same position in a consumers’ brain!
Rail franchises are often said to have economic moats, in the form of contractual certainty that they will be the sole provider of rail services for a given route. This gives them complete control of a small market and leaves their customers with few alternative options.
What else you should know about economic moats
The definition of economic moat specifically states that the advantage must be persistent. Having a trending hashtag or a successful advertising campaign does not meet the definition of a moat.
That being said, moat’s aren’t permanent, either.
A company could maintain its dominance of an industry, only to find another industry pop up which renders it obsolete (Blockbuster v Netflix is perhaps a good example).
How does the definition of economic moat relate to investing?
An economic moat is one aspect of fundamental analysis – the idea that higher returns can be yielded from well-researched investments into the right shares.