Economic Moat

What is an Economic Moat?

The economic moat term got popular by Warren Buffet – a leading American business tycoon and philanthropist. Economic moat is referred to as the ability of the business towards maintaining competitive advantage over the respective competitors for protecting the long-term Market share as well as profits from the respective competing firms.

When considered in context with a medieval castle, an economic moat helps in providing protection to those inside the castle while protecting their wealth from the intruders.

Economic Moat Meaning

There is no denying the fact that competitive advantage serves to be an essential Factor –allowing the business to provide a product or service that appears similar to the ones offered by the respective competitors. A classic instance of competitive advantage could be referred to as the concept of low-cost advantage –like providing access to low-cost Raw Materials.

Most of the successful investors out there like Warren Buffet have served quite proficient when it comes to searching for companies having solid economic moats –still lower share prices.

However, one of the most basic principles of modern Economics is that with time, competition is going to erode all possible competitive advantages that might be enjoyed by a business. The given effect is known to occur because once the business sets up the respective competitive advantages, the superior operations are known to generate increased profits for itself. Therefore, it helps in Offering a strong incentive for the respective competing firms for duplicating the methods of the given firm or finding better methods of operations.

Creation of the Economic Moat

There are several mechanisms through which economic moat can be created by a company –allowing the business to ensure a significant advantage over the respective competitors. Here are some of the common ways to achieve the same:

Cost Advantage

It is something that competitors are not capable of replicating, and can serve to be an effective form of economic moat. Companies have major cost advantages can undermine the prices of any given competitor attempting to move into the respective Industry –either by forcing the competitor to exit the industry or by impeding its overall growth.

Companies having sustainable cost advantages could look forward to maintaining large market share of the respective industry by leaving out competitors trying to move into the industry.

Size Advantage

Sometimes, being big serves to be an economic moat for the given business. At a specific size, the firm is known to achieve specific Economies of Scale. This is wherein increased quantities of goods or services get produced on a massive scale with lower costs of inputs. This helps in reducing the overall overhead costs in specific areas like production, financing, advertising, and so more.

Large-sized firms that compete in the particular industry are known to dominate the core market share of the given industry. On the other hand, the smaller business players are forced to occupy smaller roles or leave the industry.