Financial ratios tell you how a company has performed. Competitive analysis tells you whether it can keep performing. A company might have excellent margins today — but are they defensible? Will a competitor, a new technology, or a change in customer behaviour erode them? This is what Buffett means by "moat" — the width and depth of a company's competitive protection.
Michael Porter's framework assesses competitive intensity and long-run profitability potential across five dimensions:
A company with strong moats scores well across all five: high barriers to entry, low supplier power, low buyer power, few credible substitutes, and manageable industry rivalry. Google's advertising business is a classic example — enormous scale creates low costs (supplier power moot), advertisers need Google's reach (low buyer power), search dominance creates barriers to entry, and no true substitute exists for its data advantage.
| Moat type | How it works | Example |
|---|---|---|
| Network effects | More users → more valuable for every user | Visa, LinkedIn, WhatsApp |
| Switching costs | Painful and expensive to change providers | Salesforce, SAP, Bloomberg Terminal |
| Cost advantages | Scale, proprietary processes, cheaper inputs | Amazon (AWS), Walmart |
| Intangible assets | Brands, patents, regulatory licences | Apple, Novo Nordisk, Visa |
| Efficient scale | Market too small for a second competitor to enter profitably | Waste management, regional utilities |
The moat test: can you think of a realistic scenario where a well-funded competitor steals significant market share within 5 years? If the answer is no, the moat is real. If the answer is yes — or even "maybe" — the moat is weaker than the current returns suggest. High returns on capital that aren't protected attract competition. Competition erodes returns. The market eventually prices in that erosion.
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