What is an Economic Moat?
An economic moat, coined by Warren Buffett, is a structural competitive advantage that protects a company's profits from erosion by competitors, like a medieval castle's moat. Companies with wide moats sustain high returns on capital for decades, delivering superior long-term investment returns.
Five Sources of Moats
Network effects: more users increase value (Visa, Meta). Switching costs: high cost of changing providers (Microsoft Office, SAP). Cost advantages: scale or unique resources enable lower costs (Costco, TSMC). Intangible assets: brands, patents, and licenses create barriers (Coca-Cola, pharmaceuticals). Efficient scale: markets too small for profitable new entrants (rating agencies, stock exchanges).
Evaluating Moat Durability
Moats are identified by ROE and operating margins consistently above industry averages for 10+ years. But moats are not permanent. Technological disruption (Kodak), regulatory changes (utility deregulation), and shifting consumer behavior (department store decline) can erode them. Investors must assess not just moat width but durability, and watch for early signs of competitive erosion.