Of Castles and Moats

Earlier this year, my family and I spent some time in India.  I would estimate about 50% of the main tourist attractions in India are Castles or Forts–I am not completely clear what the difference is between the two.  Most of these castles have large moats around them.  I snapped multiple pictures of these moats, hoping to one day include them in a post about how vital it is for a business to have a moat.  Being the Buffett fanboy that I am, I was very proud of myself.  See pics below.

After seeing about 10 of these castles (India is filled with them), I noticed something that made me re-think my enthusiasm for a post about moats.  The castles were all  abandoned and dilapidated.  The people had moved on.  Large populated cities had moved to different areas, some close, some completely far from the original castles.

I think moats are overrated.  There, I said it.  I may never be allowed in Nebraska again, but I thought I would put it out there.

Moats may protect the valuable asset that is the castle for an extended period of time.  However, at some point, competitors will do a variety of things to combat the moat:

1. Find a different way inside the castle that wasn’t humanly possible in a previous age (fly over the castle).

2. Cut off the water supply to the castle, thereby starving the people inside (An indian prince did this to his father, thereby defeating him).  In this case, the moat proved worthless.

3. People may just move on to more fruitful territory and build their own castles elsewhere.

Tying this back to business.

A few modern examples of this…

1. Google probably has the most well-known and likely “defeat-able” moats in business these days.  It rules in search on your laptop or desktop.  However, if no one searches for things through their browser anymore, that moat will be worthless.  It will likely throw off cash for years to come and Google is desperately trying to find other revenue streams, but this castle will one day be empty.  Yes, there is a moat around the castle, but no one really defeated Google at search.  Flixster didn’t set out to defeat Google, but I don’t search for movie times on Google anymore, I search for them on my Flixster app.

2. When I lived in New York, I thought it would be a great investment to buy a taxi medallion or two.  It is essentially a monopoly, prices could only go up, right?*  10 years ago, no one could have predicted that Uber would cause prices of medallion to fall over 20% in a year (and that may be a low estimate).  Great example of a competitor finding a way to fly over a moat that the King didn’t even know existed.

3. Liquidity Services sells used goods through an online marketplace.  It is basically like eBay, but Liquidity Services manages the process more for the sellers of the items.  In one important case, that customer is the Department of Defense.  I can easily cite 10 different people who told me that this company had a strong moat because of its entrenched relationship with the Department of Defense.  This relationship was too sticky and would be too costly for the government to upend the apple cart and switch to a competitor.  The company’s contract expired, and the DoD put it out for re-bid and Liquidity Services lost the bid.  Stock has fallen over 80% since the DoD put the contract out for re-bid. [Update: I wrote this post last week and on Friday, the Company announced that Wal-Mart had cancelled their contract.  The stock lost 25% on Monday, down 88% now from the high].

Real moats are very, very rare.  If you hear hoofbeats, don’t expect a Zebra…

Even a real, strong and defensible moat may be protecting an overpriced castle.  Beware what price you pay for the treasures that lie inside.

Even if the moat is real, defensible and protecting a valuable asset, the attack may not be an actual attack.  The people may just leave and go elsewhere.

There are some moats that are real, worth it, and long-lasting.  But, Buffett has done such a remarkable job at proselytizing this message that the term moat is haphazardly applied to all sorts of business models.  Additionally, investors sometimes cover their eyes and ignore the price when paying for any sort of moat.   Vanishing Moats would be a great title to a history book about companies that died after having once thought to have a moat.  I would buy that, maybe at Borders?




*Lucky for me, we bought a run-down movie theater chain instead.  Talk about a cigar-butt.