This week’s podcast is a summary of my approach to moats in digital businesses.

You can listen to this podcast here, which has the slides and graphics mentioned. Also available at iTunes and Google Podcasts.

Here is the link to the TechMoat Consulting.

Here is the link to our Tech Tours.

Here is the mentioned YouTube video:

Here is my Moat Hierarchy:

—–

Related articles:

• AutoGPT and Other Tech I Am Super Excited About (Tech Strategy – Podcast 162)
• AutoGPT: The Rise of Digital Agents and Non-Human Platforms & Business Models (Tech Strategy – Podcast 163)
• Why ChatGPT and Generative AI Are a Mortal Threat to Disney, Netflix and Most Hollywood Studios (Tech Strategy – Podcast 150)

From the Concept Library, concepts for this article are:

• Barriers to Entry
• Competitive Advantages

From the Company Library, companies for this article are:

• n/a

—–Q&A for LLM

—-transcription below

00:05

Welcome, welcome everybody. My name is Jeff Towson and this is the Tech Strategy Podcast from Tech Moat Consulting.  And the topic for today is how I think about digital moats.  I mean, this is kind of the number one question I’ve been focused on for 10, 12 years, which is how you build, how do you measure competitive advantage moats in businesses that are digital digitizing, increasingly digital and so on.

 

00:35

You know, it’s kind of my fundamental question is this classic Warren Buffett question, does a company have a moat? Is it sustainable? How is that being changed by digital technology, which is, you know, making business a lot more ferocious, making winning much bigger, also making losing happen much faster.  So, it’s a different playing field. And as everything’s going digital, I’m trying to…

 

01:01

figure that question out. That’s pretty much the center of all my books and stuff is that question. So, I thought I’d sort of talk high level about how I think about it.  I’ve been rewriting all those books and my thinking has changed. So, I’ll give you a short version of this podcast.  I thought that’d be sort of a fun topic for today.

 

01:17

Standard disclaimer, nothing in this podcast, my writing or website is investment advice. The numbers and information from any guests may be incorrect. The views and opinions expressed may no longer be relevant or accurate. Overall, investing is risky. This is not investment legal or tax advice. Do your own research.  And with that, let’s get into the topic.  Now, before getting into the concept theory stuff, I thought I’d talk about some current events or just current uh digital tools that have emerged. I spend all…

 

01:46

maybe an hour every day looking at new gen AI tools. Because they’re coming every single day, it’s crazy.  Trying them out and it’s pretty amazing. And every now and then something really catches my attention that blows my mind a little bit.  That’s happened twice in the last two weeks.  So, I thought I’d mention that briefly.  First one is that content creators on YouTube are producing videos now.

 

02:14

that are almost as good as Hollywood. And the one I really have been watching a lot, which I’ll put the link in the show notes, is something called Star Wars, I don’t want to say it wrong, Star Wars, Tales Untold. And it’s someone, or maybe a team, I don’t know, just using generative AI video generators to create Star Wars stories. And they’re basically taking…

 

02:41

all the books of Star Wars. There was about 90, maybe 100 books written in the 80s and the 90s really building out the whole canon. I’ve read all of them twice.  A lot of my life was spent reading those.  They’re great. And then Disney bought Star Wars and it went to hell and now it totally sucks.  But old fans, who are kind of probably as annoyed as I am, started making videos based on these books and they’re fantastic.

 

03:08

They’re better than anything Disney is putting out. The quality is stunning. Now, they’re still a little glitchy in terms of dialogue and they can’t get the sword fights quite right, but I’ll put a link in the show notes. Take a look at it. It’s really in the last month or two, it’s just gone to the next level. I think you give them another six months; you won’t be able to tell the difference between Hollywood and these YouTubers just creating videos.

 

03:34

Pretty amazing. So that got my attention. I’ll put the link in there. Go take a look at it. It’s really amazing. The other one sort of snuck up on me. And I was listening, this is on YouTube as well, I was listening to some professor talk and I’d heard him voice geopolitics, not a subject I know too much about. But I remember listening to it in the car and I kind of got my attention. I was like, this man is really smart.

 

04:01

Like he’s really well spoken.  The points he’s making are subtle.  And there’s analogies he’s using, you this is like this and we compare it to that. And he’s got a very high verbal IQ. Like, clearly a very high verbal IQ. And you know, every now and then you meet someone who speaks just really well. You know, good vocabulary, very clear, crisp points. It was like that; it got my attention. I oh, that’s interesting, I don’t know this person.  It happened again yesterday.

 

04:30

I was watching this person who just does YouTube. That was a professor. The second one was just a YouTuber doing travel vlogs. Hey, this is why Cambodia is better than Philippines in lifestyle, blah, blah, you know, these sort of YouTuber travel vlogs. And the same thing happened. I sort of stopped. I said, this is incredibly well spoken. Like this person is making very crisp points and good analogies and kind of funny and

 

04:59

You know, again, I was like, this is a really high verbal IQ. I’m like, that’s strange. And my first impression was, he was really smart. And then I looked at him and I remembered the other bit, said, I noticed that they’re both reading. As they’re talking, they’re not reading, they’re not just speaking, they’re actively reading something.  And that’s when I’m like, they’re reading chat GBT.  That’s what they’re doing.

 

05:26

They are using something chat GBT or some, you know, LLM to craft very You know sort of well written Dialogues, you know, the first one was 30 minutes. The second one was like 12 minutes I said that’s really interesting that kind of got me I started to think like oh This is letting you this is letting you fake being really smart and there’s sort of two aspects to that like the first was

 

05:55

I actually think about this part a lot, that if someone has a very, a real person, has a very high verbal IQ, you know, very good with language, very good with it’s easy to mistake them for someone who’s really smart. There’s lots of cases of this, you know, all the time where because they’re so well spoken and maybe it’s a subject you don’t know that much about, you can kind of get fooled into thinking this person knows a lot about the subject. They’re not just smart, they have wisdom, they have experience.

 

06:24

Every now and then I come across someone that is like that. I’ll give you a couple examples, not to blast anyone, but there’s old guy named Thomas Friedman who used to work for the New York Times. And he’s a journalist, well, obviously, has good vocabulary, and writes very well. But he was writing about the Middle East and I used to live in the Middle East. And I remember thinking, look, he speaks very well, he’s making these points, but I’ve lived there, this is not right. Like, it’s not accurate. But if you hadn’t lived there, you wouldn’t have caught it.

 

06:52

Other people that sort of catch my attention is like there’s a senator in the US called Ted Cruz, Texas senator. Again, he speaks quite well. When you actually hear him speak about something you know, you’re like, oh, he’s not that smart. He’s just got a really good vocabulary, in my opinion. A flip, a counter argument to that would be Elon Musk. He doesn’t actually speak that well.  His vocabulary is pretty limited. He doesn’t sort of use analogies. Have you ever heard him give a speech? Like he used to give speech with

 

07:21

Donald Trump when they were campaigning.  Worst speeches like you’ve ever heard. Like, no. But, okay, the vocabulary wasn’t there, the verbal IQ maybe is not there, or he’s probably just not practiced. But obviously he knows unbelievably, he’s incredibly smart. So, he knows the subject cold, but he doesn’t express it. So, you know, I’m always sort of the lookout for someone with a really high verbal IQ where I think I’m getting fooled. And I think, oh, you know, I thought they knew this, but.

 

07:49

There wasn’t really wisdom behind that. They just fooled me with language. This is kind of a version of that because you can sound really smart in a subject and not quite know what it means and not have really any expertise. It lets you sort of fake a high verbal IQ.  Makes it really easy. Just chat, write your talk, make it clever, put in jokes and then just stare at the camera and read. Which is what these YouTubers were doing.

 

08:17

So was thinking about that. I’m starting to call it like, you know, basically fake smart.  One, it’s not what you’re thinking. Two, it’s just verbal IQ, which is not the same thing as being smart.  So, my new thing is basically if you see someone on YouTube or, you know, sort of on camera, but reading, to me, that’s the new telltale sign of, they’re using chat GBT to, you know, sound smarter than they are. Now, if you have someone

 

08:47

who’s actually very good at a subject and they’re using that to sort of take their verbiage up a level. I’m not sure how I feel about that. You’re just expressing yourself better, but you actually have the expertise underneath it. And I’m not sure how I think about that.  But my new rule is like, I’m only watching people now who are either speaking live, walking down the street, but in a way that they clearly can’t be reading something to me. Or if it’s a dialogue.

 

09:15

because then I feel like, okay, I can tell who’s actually on the ball and who’s just reading something that was written that sounds really clever.  Anyways, that one got my attention. I’ve been thinking about that a lot. uh So I was going to write a little article about that, basically called Beware of Content Creators, Faking Being Smart. It’s a thing. Anyways, those are two that got my attention. That’s a bit of a tangent, but yeah, interesting. Now I suppose the problem is, I’m counting on,

 

09:45

being able to tell that they’re reading while they’re speaking on camera. Well, you can kind of fake the videos now too. Like, you could have a sort of digital human version of yourself or someone reading or saying the words and not visibly reading. So, you can fake the video too, but right now they can’t do it too well. So maybe that’ll be a problem.  Anyways, kind of unrelated, but both of those got my attention. I’ll put links in the show notes. One for someone who I think is reading and…

 

10:15

you know on camera and then the other one for Star Wars.  Okay let’s get on the topic it’s Saturday night here at 9 p.m. so I’m a little bit relaxed today I’m flying out in the morning so I want to get this done before I get on the plane.  All right digital modes you know the story I’ve been telling for a decade is you know Warren Buffett came to Columbia Business School I went to Columbia Business School a long time ago I wasn’t there when he went but he used to show up pretty frequently because it was kind of his alma mater.

 

10:42

And at school, the story goes, a student asked him, if you could know only one thing about a company, what would you want to know? And his answer was whether it has a competitive advantage and if it’s sustainable. Now, it’s never totally been clear to me that that story’s true. People have been saying it at Columbia for years.  I think it probably is because he said similar stuff for a long time.  I interpret; that’s kind of where my starting point for all this research began.

 

11:11

And then I sort of combined it with the digital question and said, okay, really the question I’m trying to get at is how do you build and measure a competitive advantage in a digital business? It could be a business that’s natively digital, YouTube, or it could be pretty much every other business, which is going digital in some format, maybe significantly, maybe just a bit. So that was kind of my question, which led to all these books and all these articles and all that stuff.  And

 

11:41

As I’ve been sort of building out my frameworks, which I’m basically done with as of last month, I’m now sort of rewriting and I’m boiling it down to something very usable for investors and for executives.  The books which are the first ones have been rewritten. Basically, it’s like, look, there’s seven books worth of detail, but here’s the two things that matter.  If you’re an executive, here’s a playbook. That’s my recommendation. If you’re an investor, here’s a checklist.

 

12:10

So, boil it down to something useful. That’s kind of what I’m doing. And I think it worked out quite well. Okay, so my thinking on this, for those of you who haven’t looked at these books, you know, the Warren Buffett thing is, look, you got to have a competitive advantage. You have to have a moat. You have got to have a barrier to entry because business is just too difficult now. The distribution of winning and losing is getting more extreme.

 

12:36

The people who are winning, the businesses are winning, they’re winning bigger and faster than any business we’ve ever seen. Google, YouTube, and so on. But people are losing faster than we’ve ever seen before. It used to be able in business, 1950s, 1960s, you could survive for quite a long time just sort of in the middle as a mediocre so-so business.  That middle ground doesn’t seem to be very stable anymore. It’s very easy to sort of get taken out.

 

13:02

So, you got to kind of be moving aggressively to be in the top tier, to win, which means, among other things, building a moat. That’s kind of Warren Buffett, and part of that would be building a moat, that’s Warren Buffett.  The other part of that equation is Elon Musk, who’s always said, look, moats are nonsense, it’s just a fancy way of sailing oligopoly.  If you think that your only defense in this world is a moat, you’re not going to last very long. And what he would argue is, like, the real,

 

13:33

measure of competitiveness is now rate of innovation. So that’s a different approach and I’ve kind of said look you obviously have to have both. Now if you’re Coca-Cola you don’t have to innovate super-fast. Classic Warren Buffett company, big powerful moat, it’s been doing well for a hundred and what 15 years. Fantastic. Now if you’re making rocket ships or EVs

 

14:01

Yeah, you have to innovate like mad and you have to be the fastest player on the field and you’re going to have to do that just to stay at the front of the curve and stay in business. So, depending on which business you’re in, you’re going to be much more in Elon land versus Warren Buffett land. Now I think you want to be in both.  Although if someone was doing something like a soda, I wouldn’t tell them that they should be innovating like crazy in terms of Cola.  I would tell them they need to be innovating like crazy in terms of digital marketing. So

 

14:31

We can put Elon in sort of operating performance, which can be innovation, technological, it can be marketing, it can be running operational businesses like warehouses. So, I would call that sort of your operating performance has to be very, very high, no matter what business you’re in that might be innovative, it might be some of us.  And then that’s Elon Musk land and then Warren Buffett land is, and you got to have a moat.

 

14:58

That’s kind of my main thesis. put that together in what I call the moat hierarchy, where the bottom of the hierarchy is things like tactics and doing the operating basics like having a good digital core and having good, well-trained staff, having management that is good.  Those are basics. Everyone has to do those. You can’t really win there, but you have got to do them well. Tactics are the same thing.  You got to be good at marketing, responding to competitors in real time. All that stuff’s totally important.

 

15:27

You can’t really win there. It’s just sort of necessary. It’s table stakes. As you move up the hierarchy, you start to get to marathons and then you get to moats, barriers to entry, competitive advantages. Both of those I would consider a type of moat, which is they are structural.

 

15:47

Operating performance that’s about systems and people and technology  moats are about structures when I think about moats I think about machines Look an airplane is just a faster machine than a car So if you’re going to build a business, you’re better off building an airplane than you are building a car Now you don’t always get to choose that, you know certain businesses by definition and some businesses are bicycles and That’s a structural difference and the airplane just has a structural advantage

 

16:16

over the car. So, I think sort of Moats has structural advantages.  Operating performance is a mix of people, systems, technology, processes, things like that. It’s a lot more human and it’s a lot more how fast you are pedaling or how fast you are running as opposed to this is a fundamentally more powerful machine. So that’s kind of been my standard thing for many years now. So, let’s just talk about the top of the hierarchy, which is Moats.  Structural advantages, Moats.

 

16:47

This is funny because everybody talks about this, especially investors, especially value investors, Warren Buffett, value partners, Tom Russo. There’s a whole legion of value investors in this world. They’re kind of like a cult.  I’m one of them, so I’ll refer to them that way. It’s not just that it’s good thinking, Charlie Munger, Warren Buffett, and it works, which it does.

 

17:17

If you look at all this, you know how many people are going to Berkshire Hathaway this year? 40,000. I haven’t checked in a couple of years. It used to be 30, 40,000. When you see 30 to 40,000 people fly into Omaha to listen to Warren Buffett, that’s not just about getting smarter. That’s a bit more cult-like. There’s something deeper happening psychologically, emotionally, when people show up like that. And what I think it is, which is just a guess, I think people who like value investing, who think about modes,

 

17:47

When something is highly rational, it kind of resonates within them in a fairly powerful way. Warren Buffett, when he speaks about business, I really notice that it kind of moves how I’m thinking. I feel different after he speaks because he speaks in a very rational approach.  When he talks about a certain business, you know, it clicks in your mind, I got it. That sort of hyper rationality, I think it resonates in certain people deeper and I think that’s how you get 50,000 people on a plane to Omaha.

 

18:16

every year, which doesn’t happen for any other conferences. But the main point is value investing, building moats, building structures that explain why business A is better than business B.  That appeals to people, I think, with very rational minds.  Now, a counter argument to that would be Steve Jobs, who I talk about a lot. He’s a very different personality type. He’s highly creative.

 

18:44

He was some sort of Indian sherpa that walked around and never took showers for days and it was a problem for everyone at his first companies. And even if in older age, he used to walk around Palo Alto barefoot all the time. He was clearly not a hyper rational guy like Warren Buffett sitting at his desk taking apart companies by reading 10 Ks. No, he was highly creative, with a different type of personality.  So, people who are more…

 

19:13

rational I think they resonate with uh Buffett. That’s just an opinion. Then Elon Musk, he’s a maniac in the middle. He’s a hyper manic operator. know, Warren Buffett likes to sit at his desk all day long by himself in the, you know, not talking to anyone, just reading and thinking and taking apart the world. Elon Musk sleeps on the floor of his office in his factory.

 

19:40

and spends his day walking around fixing and building. mean, he’s sort of a manic engineer.  You have sort of three different personality types. And I point to these three people a lot because I think one, if you put a person around a concept, it’s easy to remember the concept. So, Steve Jobs is a very good symbol of product development and growth, uh creative.  Elon Musk is a very good symbol for

 

20:08

operating performance at the highest level.  He’s sort of this manic hyper operator who’s running four companies and building rockets on Monday and cars on Tuesday and Starlink on Wednesday. It’s crazy.  And then, know, Buffett is more of a symbol for moats and how to think about those. But their personalities, I think, sort of embody extreme versions of all three of those different things. You know, if you’re running a business, you would love to be creative like Steve.

 

20:38

You’d love to be able to operate like Elon and then to think like Warren. You’d be the ultimate businessperson.  So, I kind of like that their personalities uh mirror those types of activities. Okay, so let’s talk about moats and sort of when you talk about moats, value investors and a lot of people, they tend to use analogies to explain how these things work and what a mode is. And I don’t think any of them are terribly good.

 

21:07

the analogies people say, because I think each analogy, analogy can only really embody one aspect of what it is. I’ll give you a couple of examples. I think they capture part of what we’re talking about, but I don’t think any of them capture all of it.  I think my moat hierarchy actually captures most of the important stuff, but that’s obviously, it’s my thing, so I believe that. So let me give you two analogies, and then I’ll give you how I think about it. Now.

 

21:33

One of the standard ones that I’ve always heard and I’ve repeated it many times is, you know, sort of snowballs versus treadmills.  And the analogy goes something like this. Like there’s two types of businesses.  One is like running on a treadmill. One is like a snow bill, a snowball going down a hill and the treadmill. Okay. That’s most businesses, a lot of businesses, which is like, you have no moat, you have no structural advantage.  So, you basically,

 

22:02

have endless competitors. New entrants all the time.  And as you’re not, if you don’t have a moat, you’re basically competing on operating performance against rivals and new entrants who are pretty much doing the same basic activities you are. You’re just trying to execute them. So that’s basically like running. You’re in a race, but you’re on a treadmill.  So, you’re not really able to pull ahead of them very much. You keep running, you keep running, but the treadmill is really not going anywhere.

 

22:33

You can’t really pull ahead and you must constantly do all the things you need to do as an operating entity. You need to upgrade your facilities. You need to get better at marketing. You need to get better at your logistics, whatever. But you don’t really ever generate a lot of cash.  The other competitors don’t ever really fall behind. You never really get very far in life.  And a lot of businesses are, not a lot of, certain number of businesses are like that. You really can’t get anywhere. You’re just sort of running to survive.

 

23:01

And that’s the nature of the business. If you keep running, you can survive, but you can never really win. When I walk into a food court at a big shopping mall, that’s what I think about. I think they’ve got all this business here. They’re all right next to each other. You can’t ever really win this game. You can run, run, run and survive as a restaurant, particularly in a food court. But there’s no winning here. If you have a bad quarter, you can lose half your business. You have a bad year, you’re done, you are close. So.

 

23:30

That would be sort of  one version and there’s a,  know, the contrast to this would be the snowball, which is, okay, now you have a moat, you have a structural advantage, which means is if you pull ahead of your rivals, if you’re better than them and you build your moat, you can basically win this race. You can have your competitors fall so far behind you that they’re not a big deal.  You know, your average restaurant owner on a side street works harder.

 

23:59

on a weekly basis than Mark Zuckerberg does or at least has to. He doesn’t have any competitors, not really. Couple here and there, but he’s dominant. Coca-Cola people don’t have to work seven days a week. They could work for hours and take Friday and Saturday. People are still buying Coca-Cola every day. You might fall a little bit here and there versus Pepsi, but you aren’t going out of business in a quarter. The restaurant person can. They’re both working hard, and usually companies that don’t have moats

 

24:28

end up having to work a lot harder than those with. So, okay, you have this, the analogy is, look, it’s like a snowball rolling down a hill. Now, I know some people in Southeast Asia are listening to this who maybe don’t know it, who have never really played in snow. I keep meeting people who never like playing in snow. For those of you who don’t know, it’s snowball, you roll it on a hill with a lot of wet snow. As it goes down the hill, it kind of rolls on its own. You don’t have to push it; you just let it go.

 

24:56

It goes on its own. As it goes down the hill, it gets bigger and bigger and to a point. Okay, that’s kind of what this is. Like, look, you don’t actually have to do that much work in a business like this.  You kind of let the snowball go and gravity does the rest. So operationally, financially, you’re not really struggling that much.  Just kind of gravity helps you out. Now that’s Coca-Cola, that’s Mars, chocolate, that’s Facebook.  They don’t have to work as hard.

 

25:26

And then the other aspect is as you go down the hill it gets bigger and bigger naturally. So, you’re probably making more money, you’re getting stronger, you’re getting bigger.  It just kind of happens on its own. That’s the analogy and the woman who wrote probably the best biography of Warren Buffett, Alice Schroeder, she titled her book The Snowball. Because Buffett likes businesses that are kind of like snowballs.  And he has said, “You know, quote, life is like a snowball. The important thing is to find wet snow and

 

25:56

really long hill. Now you could say the same about business. I think he was mostly talking about business and not life.  Okay, that’s a pretty common analogy and it’s pretty good. Yeah, depending on what business you choose life can be a never-ending fight where you never really win. The other extreme is like you win once you have one good year you’ve won forever.

 

26:22

Facebook was kind of a one-time win. It has been very successful for a couple of years and it hasn’t really had a major competitor in it for 15 years. TikTok in China maybe changed that a little bit for a long time, but yeah. Now that’s a good part of the analogy. Here’s why this analogy is not good.

 

26:41

People like Hamilton Helmer, Seven Powers. When Hamilton Helmer is talking about this company having power, you know, that’s seven powers, that’s actually pretty helpful that he’s using that word, because he’s not talking about moats. Power, as he defines it, is different than moat. It’s really three factors happening at the same time. One, you have a competitive moat. You have competitive strengths. You’re defendable.

 

27:10

Now that’s what I’m talking about. That’s what my books are about. But that doesn’t necessarily mean you’re going to get growth. That doesn’t mean the snowball’s going to get bigger and bigger. You can have a very well-defended business. You know, you’re the one hospital in a small town. You’re not going to grow very much. But you’re very well defended. You know, just because you’re defended with a good moat doesn’t mean you get growth. Sometimes you do, sometimes you don’t. It depends on the market. It also doesn’t mean you’re terribly profitable.

 

27:40

You can absolutely dominate and have tremendous moats in a business that is inherently not profitable, maybe break even at best.  Companies like Didi, Uber, they have okay moats. They tend to be monopolies or duopolies in major countries like China and the US.  But then when you look at their profitability after 10 years, it’s like, wow, they’re still not making any money. They’ve had a duopoly or a monopoly for five years.

 

28:09

and they still can barely get to operating profit. Well, that’s just the nature of the business. Drivers cost money. You have competitors in taxis. You have substitutes like Metro and bus.  So, you can’t charge more than A and your cost structure can’t be less than B because of the drivers.  So, you’re kind of stuck in this little window of profitability that’s not awesome. So, you know, when Hamilton Helman talks about seven powers, he’s talking about businesses that have all three.

 

28:38

They’re defended, they have high growth, and they make money. That’s a great scenario if you can get it.  Most businesses don’t get that.  I generally like, you know, go for competitive moats as much as you can and try to grow as much as you can, because both of those things are large, to some degree, under your control as a manager.  The unit economics of your business are often out of your control. You can’t do anything…

 

29:06

If you’re in this business, you’re in that business, that’s just the way it is. But you can kind of, you know, turn the knob on growth and defensibility.  So anyways, that’s a good analogy, but I think it’s a little optimistic.  And there’s nothing wrong with that. Like, if you have a good local business, like furniture stores or gas stations in a medium to small sized town, that can be a very good business if it’s well defended.

 

29:35

doesn’t have to grow. You can have a really nice cash machine for business. In fact, I think it’s actually easier to dominate competitively a smaller market than it is to dominate a big one. It’s more likely a furniture store is going to dominate a town like Omaha, which Buffett does, than that you’re going to somehow dominate a whole country or that you’re going to dominate globally. That’s pretty rare.

 

30:02

know, most examples of domination are local service businesses, it can be, they’re not usually going to have a big growth, but they can often be very competitive. I’m sorry, very profitable.  So yeah, the whole I’ve got to dominate the world thing? No.  All right, so that’s kind of analogy number one.  It’s got some pros and cons, it’s helpful. Now, analogy number two is literally the name moat. You have a moat. What does that mean? Well, it means you have a moat around the castle.

 

30:32

You know, there’s a castle. In the castle, you have your gold. So, to make sure that nobody gets it, you dig a moat around it and you keep everybody out. Well, that’s what lot of people are talking about. You’ve got a business that is inherently profitable. And by profitability, it doesn’t have to be a cash machine. It can be your return on invested capital as a supermarket is 13 % and your weighted average cost of capital is 6%.

 

30:59

So, you’ve got a machine that turns, you put money in at 6%, you get money out at 13%. That’s very good business. You know, it’s profitable. You’re creating wealth. If you have something like that, that’s gold, you are going to attract people who are going to try and copy what you do. If you’re making money, I want to make money too. So then other people come along and they make supermarkets and they enter your business and their cost of capital is probably six or 7%. And…

 

31:28

You know, they make money too and you’re both making money, but you’ve got more competition. So now you’re not making 13%, you’re making 11%. Well, it’s still money. Someone else is going to enter. Now you have got three competitors. Now you’re all making 10 % and people are going to keep entering and entering and entering until you’re down to about 7 % return on invested capital versus 6 % cost of capital.

 

31:54

At that point, this thing is not some big gold mine that everyone was rushing towards and people are going to stop entering. That’s the sort of economic theory behind all this. And that is actually true in most markets.  Most markets are free markets with lots of entry and exit and most businesses, they might make a couple points above cost of capital. Now the world is not super

 

32:21

totally efficient. So, you can find lots of exceptions to this rule. But generally speaking, in average across industries, people don’t come in at a cost of capital of 6 % and make 35%.  Usually that gets pushed down pretty good. uh Okay, that’s fine. So, what do? Well, anyone who’s going to have sort of gold that they keep and they keep generating, you have to stop people from coming in.

 

32:47

You’ve got to block the process of new entry and more rivals coming in and keep the sort of competitive rivalry down.  That’s your moat around the castle. You have got to keep people out. And if you do that, then the money keeps going. If you don’t have that, according to the economist, your ROIC is going to drop pretty good over time, which really does happen in a lot of businesses. They do get pretty efficient over time, which is very good for consumers and customers.  It’s not what

 

33:16

know, shareholders want. You know, as Elon had said, like, moats are just a way of saying, I really like oligopolies. Which is pretty too.  That’s pretty accurate. So, if we’re going to keep, you know, the benefits of having a moat, we have to keep people out, hence moat around the castle. Sometimes people call it a franchise, different words like this. The problem with this model, with that analogy is,

 

33:43

You really have to distinguish between new entrants and rivals. You know, there are two different competitive forces.  There’s the people that are in your business that can be bigger than you or smaller than you or the same size.  What is the degree of rivalry between them? Is it ferocious? Are you really big and everyone’s really small? Are there thousands of you? Are there just three? It’s going to be very different profitability. That’s what we call a competitive advantage when you have an advantage over your rivals.

 

34:13

versus barriers to entry, which is how often do people jump into this business? How easy is it?  Well, it’s pretty easy to open a coffee shop or a supermarket on a side street.  It’s pretty difficult to open a mobile network that covers an entire large country. You need regulatory approval. You have got to build your base stations. You got a bunch of big, fixed costs. It takes some time. you know, barriers to entry, keep the new entrance in.  Competitive advantages are versus rivals, which I always

 

34:43

When I look at businesses, I always think, what is my competitive advantage versus companies bigger than me versus the same size versus smaller?  Am I on the wrong side of a competitive advantage? That happens. Now, it’s often you’re not the big player.  Usually what happens is like, I’m bigger than those companies, but I’m smaller than those big boys. What do I do? We’re a small to medium-sized you know, beauty company.

 

35:11

We do online sales of beauty products. Well, there’s Sephora, they’re giants, they’re bigger than me.  And then there’s a lot of new startups and smaller businesses. How do I beat all of them? And that’s how you kind of take it apart.  By competitive advantage and by barrier to entry and by various different types of players.  New entrants that are small.  My analogy I just said was, it looks like a bunch of YouTubers are going to be able to make Star Wars movies, assuming they don’t get pinged for the IP rates.

 

35:41

but they have the capabilities to now make movies that are as good as what we see in most of Hollywood. Most of Hollywood movies aren’t that good. So, the barrier to entry to jumping into what Hollywood does just got wiped out to a large degree. And I think it’s going away.  I think this new tech tools have democratized high quality TV and filmmaking. Definitely animation’s already there.

 

36:07

You can even make pop stars now. They’re pretty good. You can make boy bands that are virtual. They’re pretty good actually.  So, I think about it that way. So, the castle analogy is not bad. I use the castle analogy pretty good. The reason I like it is because I think keeping people out is important. And I also think it helps. You tend to think about it as a structural force.  We have big walls in a moat. That’s structural.  Okay. Let me jump to how I think about this, which was kind of the point of that.

 

36:38

My sort of recommendation, my general approach to business is, look, you have to win in the Steve Jobs growth objective first. All the moat stuff, the competitive defenses, none of that matters if you don’t have good products that people like and that you’re seeing some growth.  You have to have…

 

37:02

The car has to be moving; you have to be gaining ground. People have to like what you like before you can defend it and solidify it, if you don’t have that first part, the defense, if you have a mediocre product, the defensibility stuff isn’t going to help you that much. So, I always sort of start with sort of Steve Jobs. We need to show growth all the time, all the time, all the time. We need to improve our products. We need to improve customer experience. We need to remove the pain points.  I’m always sort of learning about online growth and improving customer experience.

 

37:32

literally every week. That to me is always sort of the main primary goal. Second, you know, we want to improve our operating performance. That may or may not be a big deal depending on what business you’re in. If you’re in e-commerce, yes, that’s true. If you’re making shampoo, no, it’s not that big of a deal. Operating performance is not huge. So, then I jumped to, you know, Warren Buffet land and we need to build our moat because we want to

 

38:02

Every year that goes on, we want life to get easier. We don’t want to be fighting as hard in year five as we did in year one. And we definitely don’t want to be fighting harder, which is often the case with restaurants. You start, it does well, it gets harder and harder. That actually is true with YouTubers and people who do e-commerce stuff online.  They might get some traction as an influencer for a couple years and make money, and then they find out it’s getting harder and harder. No, we want life to get easier and easier every year.

 

38:31

The way you do that is by building your moat systematically year after year.  That is sort of my general bias for how you sort of approach digital business overall. And within that, you never really want to fight fair.  Like I never want to be in a fair fight.  Everything I just said, hey, we need to grow aggressively every year. We need to improve our products every year.  And we need to build our moat. That’s all true, but it’s much better to be doing that.

 

39:00

with some sort of trick. Like, let’s go to the part of town where nobody else is yet. Fewer competitors, that strategy’s going to have more power there.  Let’s go into a business where the incumbent’s kind of suck. One of the problems with digital business is, is you’re always going up against other digital businesses that are really, really smart and really good at what you do. Tencent is fighting Alibaba.

 

39:27

It’s not good to have a super smart, super effective competitor.  It’s much better to be competing as someone who aren’t that good.  Elon Musk has his Tesla, which struggles because it turns out, look, Japanese and German car companies and now Chinese companies, they make really good cars. So, the competition is serious. SpaceX, in contrast, has largely been competing with bloated government contractors.

 

39:57

who are really good at cost plus pricing and just want to sort of make the contracts as big and as positive. They’re not terribly ferocious competitors. And there aren’t that many of them. You know, that’s a much better strategy. So, get there early.  Go to where other people aren’t. If you have to compete, compete against people who suck if you can. Things like that. But you know, don’t fight fair.  Don’t cheat, don’t break the law, but don’t fight fair. Make sure you have an advantage.

 

40:25

If you want to win in boxing, get into the ring with someone who’s 50 pounds lighter than you.  You’ll be the champion.  So that’s kind of my bias. Anyways, when I think about modes, the way I, the story I tend to think about is, which I made the story up, it’s not awesome, but I think it gets the point across. know, chicken restaurants versus like Starbucks. You go to any street, any city,

 

40:52

You’ll see restaurants, you’ll find streets with lots and lots of restaurants on them. And chicken is usually pretty popular anywhere you go. So, a typical commercial street, well again, let’s say it has a lot of restaurants. And let’s say 30 % of them are chicken restaurants, which tend to be popular in this particular demographic.  And we see traffic, we see people walking up down the street, it’s not deserted or anything.  You know, most of the restaurants are getting some business, some are getting some more than others, but they’re all kind of getting some business.

 

41:22

Probably none of those chicken restaurants are making that much money. Maybe one’s doing better, but it’ll tend to come and go. Oh, he had a good year, now this one’s better. But you’ll see market share shift a lot in that dynamic. And then let’s say one day one of the chicken restaurants, maybe they’re having more difficulty than others. They put out a big thing. Our three-piece dinner’s now 25 % off. Big signs all up and down the street. Well.

 

41:51

What did the other restaurants do? Did they ignore it? If they ignore it, they’ll probably lose some business. Did they drop their price and match the promotion? If you do that, let’s say they did that, okay, you’ll probably keep your market share, but everybody’s revenue just went down a bit. And maybe that persists and that’s the new baseline. Or maybe that lasts for a month and then everyone goes back to normal because it was not a good idea. We see that all the time. Let’s say…

 

42:18

Another chicken restaurant decides I’m going to do a lot of marketing and they put ads all over the street and on food delivery apps they’re popping up and they’re getting promotions and things like that. They basically decided to look we’re not going to cut our prices but we’re going to boost our marketing budget by 20 percent.

 

42:37

Okay, the other restaurants on the street all have to decide what to do. Are we going to boost our spending on Grab or Uber Eats? I don’t know, maybe. Now maybe if we don’t do that, we’ll probably lose some business. Maybe that won’t be so bad. Maybe we’ll keep our business, but we didn’t have to spend all that marketing money. Okay, maybe we will do this and we will keep up our business, but now our expenses have gone up so our profits are lower. You have got to figure out what to do. Let’s say one of the restaurants says,

 

43:07

You know, we’re going to do a major renovation. We’re going to add a kiddie place because we want families to come to us.  And if we have a kid play area, we think the families will come so that they’ll stay longer. They’re older. All right. So, they’re going to do some capex. Do we have to build a kiddie center to a family center in our, in all of our restaurants? That’s going to be some capex.  So, I know as the point is, um,

 

43:33

When you don’t have a moat, and I’ve run a couple restaurants, I haven’t run them, I’ve been involved in a couple. What always struck me about running the restaurant or being involved in restaurant is we didn’t have any control over anything. We had lots of competitors, they were all doing stuff like this all the time, and we always had to respond to what they were doing.

 

43:55

And their actions could hit us on literally every level of our income statement. It could hit our revenue with the discount.  It could hit our marketing expenses with the promotion. It could hit our capex with new center like a kid.  You were just always responding, struggling to survive. And it’s a very difficult way to live as sort of a manager and an owner and definitely for investors, because you have very little predictability in this type of business. You can have a good quarter, a bad quarter.  Your profits can go up and down.

 

44:25

And you know, so the bias that I keep is, look, a lot of things can impact the trajectory of your business. Regulatory change, technological change, consumer behavior change, digital change, but competitor actions hit you quicker and more severely than just about anything. They can hit you every day of the week with a new thing you have to respond to, and you will see it in your income statement within days. You know, it’s sort of the most

 

44:55

ferocious end of competition and change. So that’s chicken restaurants. Here’s the Starbucks counter example. Let’s say same commercial street, but now we’re looking at coffee shops. know, lattes, espressos, all the products at all the coffee shops are pretty much the same. Some drinks, some muffins, maybe a bagel, maybe they got matcha tea. But, and again, we’re seeing traffic up and down the street.  Most of the businesses are making maybe okay.

 

45:26

operating profit, yeah maybe enough to stay open. But then on the corner right at the intersection there’s a big Starbucks and it’s bigger than the other coffee shops on the street and it’s in the most prominent position relative to traffic. It’s got high visibility; it’s got higher traffic based on its location and the fact is bigger. It’s big, they also have Wi-Fi, they have seating and things like that. Okay, that’s interesting.

 

45:56

Now let’s say one of the coffee shops says we’re going to drop the price of our lattes by 20 percent, just like the chicken example. What do the other coffee places have to do? Well, they have the same problem as the chicken places. Maybe they drop their prices, maybe they don’t, maybe they respond, maybe this lasts for a couple weeks, maybe it’s the new baseline. But then we kind of noticed that Starbucks doesn’t really do anything. It just kind of didn’t respond. I don’t even know if it noticed.

 

46:25

It didn’t seem to care. It didn’t change its prices at all. Now let’s say there’s another coffee shop and they love their sort of do an advertising blitz.  We’re going to spend money on Uber Eats and Grab and we’re going to do promotions, and lots of market. We’re going to basically boost our marketing budget by 20%. Same scenario, same thing happens. But again, Starbucks just doesn’t do anything. They don’t change their marketing at all.

 

46:52

Now let’s say something bigger happens like macro. There’s a drop in tourism from China to Thailand. Let’s say they all decide to go to Vietnam this year, which they kind of did. Okay, we’ve got 20 % lower traffic than we normally get. Everybody kind of takes a hit. Everybody’s business is going down. But then you look at Starbucks and you’re like, huh, they went down, but they didn’t take as big a hit for some reason. Some reason they went down less than everybody else.

 

47:21

That’s interesting. Or let’s say they open a new metro at the end of the street. Oh, that’s good news. More traffic. People are coming up. The overall volume of traffic on the street goes up.  Everybody goes up. But we notice that Starbucks went up more than everybody else. That, to me, is how I think about moats. That little story versus chicken restaurants. Why?

 

47:44

They don’t have to respond to what everyone else is doing.  Yes, I mean they have their moat. Starbucks has a pretty good motor which is basically based on, people think it’s brand, it’s not really brand, it’s more about location. Their sort of operating outlet footprint gives them high traffic and high visibility locations which drives more traffic which means they sell more which means they can spend more on real estate. They kind of have economies of scale based on real estate spending.

 

48:13

And then in addition they have, they can outspend their rivals on marketing and things like that. And then they have loyalty programs, which is a type of switching cause. They actually have a pretty decent competitive advantage.  It’s not super powerful like Pepsi, but it’s pretty good. But what you see is like, you know, most businesses, their days and weeks are shaped by what others do and they’re always responding.  But a company like Starbucks in the same scenario, it just sort of is immune to so much of this.

 

48:43

Not only is it not spending all this time responding, oh, what did they do? What are we going to do? What did they do? So, one, it’s not playing that game. But two, it’s also focusing on its own plan. Regardless of what their competitor’s doing, they have their own sort of playbook.  They know what winning looks like and how they’re going to get there. And every year they’re closer and every year their life gets easier. So, you free yourself up from the daily back and forth of tactics.

 

49:13

and you spend more time building your moat for the long term. Now I kind of call this the do you control your own destiny question and that’s how I think about moats. This was an old Tom Russo, the investor.  You know the simplest strategy I use for business; I literally call it the control of your own destiny strategy.  Look we can’t necessarily guarantee you’re going to make a huge amount of money. That’s going to be determined by your industry. We can’t necessarily.

 

49:43

grow beyond a certain point that might be determined by me market but we can take actions that give you control of your destiny  more than you have today  you’ll be able to sort of chart your own path you won’t be at the mercy of external forces  day after day forever  you can sort of chart your own course through life and I find that sort of I think the goal of a lot of this and it puts you in the best possible position  so then if you know there are opportunities you can jump after them

 

50:12

So that’s kind of my, when I think about competitive defensibility and moats, I sort of break it down this way of that chicken versus Starbucks analogy is I think what most companies are actually dealing with. Most companies are not Google search, they’re not Amazon, they’re not Coca-Cola. Most companies are dealing with some version of that chicken versus Starbucks story. Usually not with hundreds of restaurants, but usually five, 10, 15 competitors.

 

50:41

And you want to, if you’re stronger within that scenario, you can be more like Starbucks. And you don’t really want to go through life as a chicken restaurant. You know, it’s sort of a tenuous, uncertain way to live. Anyways, that’s it for today. I did kind of go off pretty good on that subject.  I actually thought this was going to be shorter, but nope, that was pretty long.  It was all put in my basic sort of moat hierarchy.

 

51:05

And the higher you go on with the hierarchy, the easier life becomes. The higher you go up from tactics to digital operating basics to barriers to entry to competitive entries, the more you go up, easier life becomes and the more control you have over your destiny. That’s kind of how I think about it. Okay, that is it for me for today. I got to pack up. I’m going to be in the Philippines for a couple of days.  That should be a lot of fun. I’m actually looking forward to that. And yeah, it’s going to be a great week. I hope everyone’s doing well and I’ll talk to you next week.

 

51:35

Bye bye.

 

——-

I am a consultant and keynote speaker on how to increase digital growth and strengthen digital AI moats.

I am the founder of TechMoat Consulting, a consulting firm specialized in how to increase digital growth and strengthen digital AI moats. Get in touch here.

I write about digital growth and digital AI strategy. With 3 best selling books and +2.9M followers on LinkedIn. You can read my writing at the free email below.

Or read my Moats and Marathons book series, a framework for building and measuring competitive advantages in digital businesses.

Note: This content (articles, podcasts, website info) is not investment advice. The information and opinions from me and any guests may be incorrect. The numbers and information may be wrong. The views expressed may no longer be relevant or accurate. Investing is risky. Do your own research.