Last week two of my all-time business heroes -- Warren Buffett and Elon Musk -- exchanged friendly barbs regarding the advantages of competitive moats around businesses. The term "moat," as it is used to refer to a business, was originally coined by Buffett some 40 years ago to describe the kind of competitive advantage he seeks in any long-term investment (and basically all his investments are long-term).
Buffett said Berkshire Hathaway looks for companies that have some sort of advantage over other companies that will allow them to sustain their success over the long term. According to Buffett:
"The moat in a business like our auto insurance business at GEICO is low cost... Most people will assume the service is fairly identical among companies, or close enough, so they're going to do it on cost, so I gotta be the low-cost producer. That's my moat."
But Musk took issue with this widely accepted business strategy in a Tesla earnings call last week in which he was particularly cantankerous (even for Elon):
"I think moats are lame... What matters is the pace of innovation. That is the fundamental determinant of competitiveness."
So what is it? Whose point of view is correct? Are moats a valid business strategy or not?
The answer is yes, they are. But also, um, no, not for very long. Moats are still a legitimate business strategy, but they can't be expected to protect a business for nearly as long as once was possible. Why? Because of the pace of innovation, like Musk said. It takes much less time today to replicate a competitor's business model or strategy than it ever used to.
Technological change has dramatically accelerated the competitive "game clock," and if you think about your own experience you might come up with your own examples of how competition in all categories has been speeding up.
There is, however, a different kind of business-strategy moat that actually does have the capability of enabling a company to preserve its competitive advantage over the long term, even in the face of disruptive technological change: A customer moat.
Again, you might have noticed a few examples of this in recent years. Apple, Amazon, USAA, Google, and a few other companies have created businesses that depend for their success on earning the trust and confidence of a core group of customers -- not just by using technology to streamline the customer experience, but also by being trustable. These businesses work proactivelyto protect each customer's interest, even when there's no quarterly profit in it.
And so, rather than setting up a moat around a particular business model (with the constant danger of the moat being breached by technological disruption), these companies have earned the loyalty of a large group of customers who prefer buying from them regardless of the category or business model. And now these customers represent their moat.
Think about it: Apple began as a computer company, plain and simple. But their constant and careful focus on the user experience has created a terrifically loyal customer base that has followed the company as it ventured into the music category, the phone category, the tablet category, the cloud memory category, and the payments category. Amazon was once simply an online book store, but its focus on customers has allowed it to develop into one of the world's largest retail operations, a highly successful video producer, and arguably the world's best cloud computing platform as well.
Businesses that want to preserve their competitive advantage in the even faster-paced innovative future must not just be good at innovating themselves; they must also be good at establishing customer moats based on trustability.
A company that sets up a customer moat based on proactively watching out for their customers' best interests will be able to prosper over the long term, even in the face of significant technological disruption. Why? Because their customers will want to do business with them in the future, and they'll want to do so not just in the company's current business category, but in any category.