How to Measure a Business Moat?
What makes a great business?
As an investor and entrepreneur, it’s a question I think about a lot. Ultimately, the best businesses can stand the test of time and fend off competition. They have staying power thanks to something called a “moat.”
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What is a Moat in Business?
A “moat” refers to how well a company can protect its position from competitors. Just like a medieval castle is protected by a water moat, great businesses are protected by defendable advantages.
There are two main types of moats:
Structural Moats
Some companies have structural moats built into their business model, products, or networks:
- Economies of scale – Cost advantages from size and production volume. Large companies can negotiate cheaper rates and pass savings to customers.
- Network effects – Products or networks that become more valuable as more people use them. Think Uber, and Facebook.
- Switching costs – High costs for customers to change to a rival product or service.
Intangible Moats
Other moats come from hard-to-copy intangibles like:
- Brand – Trust, reputation, and customer relationships that drive loyalty.
- Culture – Values, talent attraction, and coordination abilities.
- Patents – Legal protection over innovations and intellectual property.
The best companies have multiple moats protecting profitability. The more moats, the better!
Why Measure the Moat?
Let’s think like medieval castle designers. The deeper and wider the moat, the harder it is to invade.
Similarly in business, measuring the moat helps us evaluate competitive threats. We want to invest in and build companies with the strongest and most durable protection.
How to Measure Business Moat Depth
There’s no one perfect way to measure a company’s moat. Each business and industry has different dynamics. But here are 5 helpful approaches:
1. Profit Margin Analysis
Look at gross, operating, and net profit margins over time.
- Wider moats tend to enable higher and more consistent margins.
- Narrow moats show greater volatility and competition.
For example, Apple has maintained ~38% gross margins for over a decade thanks to brand loyalty and differentiation. Meanwhile, deteriorating margins signaled increasing threats to PC makers like Dell.
2. Market Share Trends
Analyze market share over 5-10 years.
- A fortified castle retains or grows share as the population expands.
- A crumbling fortress loses ground to rivals and newcomers.
For example, the rise of smartphones quickly eroded Nokia and Blackberry’s 80-90% cell phone market share. Their moats sprung leaks.
3. Customer Churn
Measure customer loss rates, especially among big accounts.
- Strong wide moats have higher customer retention and loyalty. Competitors struggle to poach users.
- Weak moats suffer more defections, indicating they fail to satisfy and protect customers.
For example, Amazon Prime retention exceeds 90%. High switching costs and satisfaction lock users into Bezos’ empire.
4. Review Competitor Threats
Study existing rivals and scan for new upstarts.
- How easily can they copy or substitute your product, technology, or business model?
- What do their financials and market share trends reveal about their momentum?
Uber’s network effects and scale didn’t stop Lyft and others from copying and claiming 30-40%+ of key markets like NYC and LA.
5. Surveys
Ask customers directly about competitiveness, differentiation, and willingness to consider alternatives.
- Strong moats see less vulnerability to competitors. Users cite unique benefits.
- Weak moats reflect openness to switch if better options exist.
User surveys exposed Walmart and Amazon’s growing threats to niche retailers years before mass closures hit Main Street.
While no measure is perfect, together these analyses reveal the competitive “lay of the land” and depth of your business moat.
How to Measure Moat Width
Moat depth shows strength against current rivals. Equally important is how well the moat protects from future threats – its width:
- Wide moats can deflect attacks from unexpected angles like disruptive innovation.
- Narrow moats are prone to creative destruction by startups.
Here are 3 tips to check your moat’s width:
1. Conduct War Games
Envision worst-case scenarios and imagine emerging competitors aiming to dethrone you. Probe for unconventional weaknesses.
- What if a startup offers your product for free?
- How could AI and automation impact demand long term?
General Motors dismissed early electric vehicles as niche products for environmentalists and techies. Tesla’s vision exploited a much wider consumer appeal that eventually cracked GM’s chassis. Had GM war gamed such attacks on its fortress, history may have played out differently.
2. Study Market Outliers
Pay special attention to data points that don’t fit expectations, like surging niche brands.
Outliers often foreshadow the future, revealing consumer demand for new use cases. Don’t ignore anomalies – let them guide your paranoia!
Barnes and Noble waited while Amazon opened new fronts, siphoning book sales online and pioneering e-readers. The outliers signaled vulnerabilities Barnes and Noble failed to fortify in time.
3. Talk to Consumers
Interview diverse consumers – not just current users – about applications you haven’t considered.
Seek ideas for how your product could better solve emerging jobs to be done. New use cases indicate stretches of dry moat that should be flooded ASAP.
Had Kodak listened to consumers frustrated sharing photos from their digital cameras, they may have pivoted faster into mobile apps and prints. Protect your flanks!
While no general can guarantee against unknown future innovations, envisioning change expands your moat’s width. Don’t let skeptics deter your creative paranoia!
In Conclusion
Every great business resides in a castle, protected by defensive moats against competition. As entrepreneurs, our job is to construct the deepest, widest moats possible.
By continually measuring moat depth and width from multiple angles, we can spot vulnerabilities early and take corrective actions. We can identify where to focus – be it boosting brand power, improving efficiency, or locking in users with network effects.
Building a fortress business isn’t easy or linear. Priorities and threats shift constantly. But armed with the right insights and vision, we can future-proof our kingdoms to stand the test of time.
Now rally the troops and replenish the boiling oil reserves! We have an empire to build and competitors to repel! Who among you dares attack my mighty moat?
