|Course 206: More on Competitive Positioning|
|Wide Moats Versus Deep Moats|
With the concept of a wide moat firmly in place, it's also important to realize that the width of a firm's moat, or how broad and numerous its competitive advantages are, matters more than the moat's depth, or how impressive any individual advantage is. Discerning between width and depth can be difficult, however.
First, it's absolutely critical to understand not only what an economic moat is, but also how it translates to above-average returns on capital. Many investors easily surmise the first point about moats--that a competitive advantage is required--but they miss the importance of the second point, above-average returns. If the business doesn't throw off attractive returns, then who cares if it has a competitive advantage? Autos and airlines are two businesses with some barriers to entry, but few new competitors are trying to crash the party in a race for single-digit ROEs or bankruptcy.
Over the years, Warren Buffett has frequently referred to his desire to widen the moats of his companies, but it's rare to see him refer to a moat's depth. Buffett's frequent talk of moat width--and silence on moat depth--speaks volumes. Michael E. Porter has said, "Positions built on systems of activities are far more sustainable than those built on individual activities."
Unfortunately, no company is going to tell you if it has a moat, much less whether that moat is of the wide or deep variety. If a firm has a competitive advantage, it behooves it to not tell you how its moat has been built. After all, you just might emulate it.
Still, it can be worth investors' time to ponder whether the stocks they're invested in have one really fantastic competitive advantage that, while deep, may lack width, or if they're invested in firms with a series of advantages that can sustain above-average returns on capital over the long haul.
Consider well-run giant conglomerates like General Electric GE or Citigroup C. Finance theory tells us that these decades-old firms should have seen their returns on capital dribble down to their cost of capital ages ago due to rivals competing away the excess returns. (We'll talk much more about returns on capital and cost of capital in coming lessons.) Yet, Citigroup's ROEs are still in the upper teens even in a bad year.
Why haven't competitors captured these profits? Quite simply, these firms are pretty good at an awful lot of things. If Citigroup is hobbled by problems in its private banking unit or regulatory scandals on its trading desks, it can rely on its impressive credit card operations and retail banking business to carry the day. At GE, if new competition from cable hurts the NBC network or its insurance division posts lackluster returns, it can rely on a cadre of numerous other good businesses to pick up the slack. Like stacked plywood, each of these businesses is strong in its own right, but virtually indestructible together.
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