Economic moat

Welcome to my first post for 2011!

Warren Buffett always like business with a wide economic moat. In the 1995 Annual General Meeting of Berkshire Hathaway, he had this to say of economic moat: “Wonderful castles, surrounded by deep, dangerous moats where the leader inside is an honest and decent person. Preferably, the castle gets its strength from the genius inside; the moat is permanent and acts as a powerful deterrent to those considering an attack; and inside, the leader makes gold but doesn’t keep it all for himself. Roughly translated, we like great companies with dominant positions, whose franchise is hard to duplicate and has tremendous staying power or some permanence to it”.

So, what constitutes a moat? There are five ways in general that a company can build sustainable competitive advantage:

  1. Real product differentiation (by using superior technology or features)
  2. Perceived production differentiation (through a trusted brand or reputation)
  3. Driving costs down
  4. Locking in customers (by creating high switching costs)
  5. Locking out competitors (by creating high barriers to entry/success)
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