A moat isn't high margins. It's how long they last
Originally written in Chinese. Translated with AI, reviewed by Gary. Read the Chinese original →
I came across some discussions about "moats" and found them really interesting.
When many people hear "moat", their first reaction is: is this company making money right now? Are its profits high?
But from the point of view of professional investors, making money is often just the result. What they really want to see isn't how much you make today, but whether you can keep making money like this for the next five or ten years.
Simply put, a moat isn't a high profit margin. It's how long that margin can last.
Say in an ordinary industry everyone averages a 10% gross margin, but you can hold 30% over the long run. That extra 20% is what might be your moat.
The question is: why are customers willing to pay you more? Why is it hard for competitors to knock you down? Why won't the market quickly eat away your profits?
That's the key.
But high profits don't necessarily mean you have a moat.
The games industry is a good example. Some games can have margins of 70% or 80%, which look beautiful. But if nobody's playing three years later, that profit wasn't a moat. It was just a cyclical windfall. Making a lot when the wind is behind you doesn't mean you'll still be standing once it dies down.
Five sources of a moat
There are roughly a few ways to look at a moat.
The first is cost advantage.
This is actually the scariest. Companies like Apple and Uniqlo aren't just great because of good products. Their supply chains are incredibly strong. Something others might need RM100 to make, they might make for RM60 or RM70. That means they can fight a price war if they want, or protect their margins if they want. That's a very deep advantage.
The second is network effects.
Many people confuse network effects with traffic. Lots of traffic doesn't mean you have network effects. A real network effect is when the more people use your product, the more valuable it becomes, and the harder it is for later users to leave. Things like WeChat, Facebook and Instagram: the more users, the stronger the value, and the harder it is for competitors to copy.
The third is switching costs.
Say a company uses a particular ERP system, the staff are trained and the processes run smoothly. Even if a competitor says it's cheaper and more advanced, the company won't switch lightly. Changing systems isn't as simple as buying software. Behind it are time, processes, training, risk and organisational cost.
The fourth is intangible assets, such as brand.
What is a brand? Put simply, it's when you sell the same thing for 20% more and customers still buy it. That's a brand. Many online brands just have good traffic, lots of discounts and low prices, and that isn't necessarily a brand. A real brand is when customers are willing to pay a bit more because they trust you, like you and identify with you.
The fifth is economies of scale.
When a company gets very big, its purchasing, logistics, systems, team, data and channels all become advantages. It's not that others can't do it, but it takes a long time and a lot of money, and even if they spend it, they may not catch up.
The ability to survive cycles
At its core, a moat is whether a company has the ability to survive through cycles.
Selling masks during the pandemic made lots of money, but that didn't mean you had a moat. The real test is whether you can still do well after the pandemic is over. A tailwind can make you fly, but your moat decides whether you survive when you fall.
There's a fun test:
If I gave your competitor US$100 billion today, plus five years, could they do better than you?
If yes, your moat isn't actually deep.
If that would be hard, then you really have something.
That's also why running a company can't just be about this quarter, or a year or two, or even just how much you're making now. A truly good business is one that, five or ten years later, after the environment, the platforms, the consumers and the competitors have all changed, can still keep making money.
That's a moat.
It isn't how fast you're running today.
It's whether you're still standing after time has passed.