The five sources of moat
Network effects, switching costs, cost advantage, intangibles, efficient scale — and where each advantage actually lives.
The previous lesson ended on a test: what would actually stop a well-funded competitor from replicating this business?
Almost every honest answer to that question falls into one of five categories. Learning to say which one applies — and to notice when the answer is none of them — is the core skill of moat analysis.
Work through all five below. Each one carries the mechanism, a company you can go and check, and what the committee looks for in the filings when it is testing for that particular advantage.
One moat is usually enough, and two is rare
Most durable businesses have exactly one of these, working hard. A few have two that reinforce each other — Visa has network effects and efficient scale, and the combination is why it has been difficult to dislodge for sixty years.
Be suspicious of a thesis that claims four. Either the analysis is being generous with the definitions, or the mechanisms are being described in four ways rather than found in four places.
The question that separates them
The five sound distinct in a list and blur in practice, so it helps to have one question that tells them apart:
Where does the advantage actually live?
If you cannot say where it lives, you have probably found a company that is merely doing well.
What weakens each one
A moat is a live assessment, so it is worth knowing what each kind dies of:
- Network effects fail to multi-homing — when customers can use several
competing networks at once, no single network's size is worth much.
- Switching costs fall when a competitor pays to remove them, or when the
underlying data becomes portable by law.
- Cost advantages are the least durable: a rival with enough capital can
usually buy the same scale or the same technology.
- Intangible assets expire. Patents run out on a schedule you can look up;
brands decay slowly and can be destroyed quickly.
- Efficient scale breaks when the market grows enough to support a second
operator — which is why a moat of this kind is threatened by demand rising, the one risk that looks like good news.
The next lesson takes a framework built for exactly this — Porter's five forces — and uses it to work the question from the outside in.
Follows Berkshire Hathaway shareholder letter, 1995.