Warren Buffet famously says that he won’t invest in a company unless it has an economic moat. Just like castles of the past had moats for protection, you need to build a moat around your customers to keep competitors from taking them away. The challenge is that Buffet doesn’t define what a moat is exactly. Other investors and pundits talk about moats but they focus on whether companies possess them already and how you can tell if they have one.
What executives need to know is what moats are and how to build one. They need to know the precursor to the economic success of a moat. It’s the difference between knowing the score of a football game, and knowing the game plan that went into winning it. Our saying at wRatings is Go For The W™.
Most seminal work in this area traces back to Michael Porter’s Competitive Strategy (1980) where he describes the five forces of industry competition: Substitutes, Suppliers, Buyers, Competitors and Potential Entrants.
In today’s complex world with seemingly endless choices, one of Porter’s five forces is far more critical. Companies that limit Potential Entrants by building barriers to entry don’t have to worry as much about the other four. That’s what a moat is, a barrier to entry so wide and deep that competitors can’t penetrate it to take your customers away.
In the 2000s, we went in search of moats, or more accurately how moats look from a customer’s perspective. We conducted two studies from 2001-2005 and then again from 2005-2015. First, we analyzed which companies were able to maintain their revenue share at the 65th percentile when compared to their industry peers. We added in ROIC (return on invested capital) as a second criteria. From over 2,600+ companies, we found only 15 that met the thresholds.
Starting with those 15 companies, we analyzed their performance levels to meet customer expectations across a myriad of functional and emotional needs. The analysis found unique patterns within the data. Each pattern of customer expectations and company performance clearly identified a moat and, most interestingly, where to focus performance areas in order to build that moat.
Our second 10-year study added in revenue growth to complete the 11-moat framework. We divided the moats into three groups of how customers make buying decisions: Why, How and What.
The W Report™ shows well your company performs by force ranking it against our W-50 competitive benchmarks. This analysis provides executives and investor relations professionals with a fully independent assessment of the competitive strength of their company. Through our moat framework, executives can work on the right initiatives today with confidence they are creating durable competitive advantages in the future.