What Is a Moat?

How Do Economic Moats Help My Startup?

In business, an economic moat is the attribute that allows an organization to outperform its competitors. An economic moat may include access to natural resources, such as high-grade ores or a low-cost power source, highly skilled labor, geographic location, high entry barriers, and access to new technology.

Overview of Economic Moats

Economic moats is the leverage a business has over its competitors. This can be gained by offering clients better and greater value. Advertising products or services with lower prices or higher quality piques the interest of consumers. Target markets recognize these unique products or services.

This is the reason behind brand loyalty, or why customers prefer one particular product or service over another.

Value proposition is important when understanding economic moats. If the value proposition is effective, that is, if the value proposition offers clients better and greater value, it can produce an economic moat in either the product or service. The value proposition can increase customer expectations and choices.

Michael Porter defined the two ways in which an organization can achieve economic moats over its rivals: cost advantage and differentiation advantage. Cost advantage is when a business provides the same products and services as its competitors, albeit at a lesser cost.

Differentiation advantage is when a business provides better products and services as its competitors. In Porter's view, strategic management should be concerned with building and sustaining economic moats.[1]

Economic moats seeks to address some of the criticisms of comparative advantage. Economic moats rests on the notion that cheap labor is ubiquitous and natural resources are not necessary for a good economy.

The other theory, comparative advantage, can lead countries to specialize in exporting primary goods and raw materials that trap countries in low-wage economies due to terms of trade. Economic moats attempts to correct this issue by stressing on maximizing scale economies in goods and services that garner premium prices (Stutz and Warf 2009).[2]

The term economic moats refers to the ability gained through attributes and resources to perform at a higher level than others in the same industry or market (Christensen and Fahey 1984, Kay 1994, Porter 1980 cited by Chacarbaghi and Lynch 1999, p. 45).[3]

The study of this advantage has attracted profound research interest due to contemporary issues regarding superior performance levels of firms in today's competitive market. "A firm is said to have an economic moat when it is implementing a value creating strategy not simultaneously being implemented by any current or potential player" (Barney 1991 cited by Clulow et al.2003, p. 221).[4]

Successfully implemented strategies will lift a firm to superior performance by facilitating the firm with economic moats to outperform current or potential players (Passemard and Calantone 2000, p. 18).[5]

To gain economic moats, a business strategy of a firm manipulates the various resources over which it has direct control, and these resources have the ability to generate economic moats (Reed and Fillippi 1990 cited by Rijamampianina 2003, p. 362).[6] Superior performance outcomes and superiority in production resources reflect economic moats (Day and Wesley 1988 cited by Lau 2002, p. 125).[7]

The quotes above signify economic moats as the ability to stay ahead of present or potential competition. Also, it provides the understanding that resources held by a firm and the business strategy will have a profound impact on generating economic moats.

Powell (2001, p. 132)[8] views business strategy as the tool that manipulates resources and creates economic moats. Hence, viable business strategy may not be adequate unless it possesses control over unique resources that have the ability to create such a relatively unique advantage.

The Three Forms of Competitive Moats

Michael Porter, a graduate of Harvard University, wrote a book in 1985 which identified three strategies that businesses can use to tackle competition. This book was named the ninth most influential management books of the 20th century.

These approaches can be applied to all businesses whether they are product-based or service-based. He called these approaches generic strategies.

They include cost leadership, differentiation, and focus. These strategies have been created to improve and gain an economic moat over competitors. These strategies can also be recognized as the comparative advantage and differential advantage.

Cost leadership strategy

Cost leadership is a business' ability to produce a product or service that will be at a lower cost than other competitors. If the business is able to produce the same quality product but sell it for less, this gives them an economic moat over other businesses.

Therefore, this provides a price value to the customers. Lower costs will result in higher profits as businesses are still making a reasonable profit on each good or service sold. If businesses are not making a large enough profit, Porter recommends finding a lower-cost base such as labor, materials, and facilities.

This gives businesses a lower manufacturing cost over those of other competitors.[9] The company can add value to the customer via transfer of the cost benefit to them.

Differential strategy

A differential advantage is gained when a business's products or services are different from its competitors. In his book, Michael Porter recommended making those goods or services attractive to stand out from their competitors. The business will need strong research, development and design thinking to create innovative ideas.

These improvements to the goods or service could include delivering high quality to customers. If customers see a product or service as being different from other products, consumers are willing to pay more to receive these benefits.[10]

Focus strategy

Focus strategy ideally tries to get businesses to aim at a few target markets rather than trying to target everyone. This strategy is often used for smaller businesses since they may not have the appropriate resources or ability to target everyone.

Businesses that use this method usually focus on the needs of the customer and how their products or services could improve their daily lives. In this method, some firms may even let consumers give their inputs for their product or service.[10]

This strategy can also be called the segmentation strategy, which includes geographic, demographic, behavioral and physical segmentation. By narrowing the market down to smaller segments, businesses are able to meet the needs of the consumer.

Porter believes that once businesses have decided what groups they will target, it is essential to decide if they will take the cost leadership approach or differentiation approach. Focus strategy will not make a business successful. Porter mentions that it is important to not use all 3 generic strategies because there is a high chance that companies will come out achieving no strategies instead of achieving success.

This can be called "stuck in the middle", and the business won't be able to have an economic moat.[11]

When businesses can find the perfect balance between price and quality, it usually leads to a successful product or service. A product or service must offer value through price or quality to ensure the business is successful in the market.

To succeed, it’s not enough to be "just as good as" another business. Success comes to firms that can deliver a product or service in a manner that is different, meaningful, and based on their customers' needs and desires.

Deciding on the appropriate price and quality depends on the business's brand image and what they hope to achieve in relation to their competition[12]


References

  1. Porter, Michael E. (1985). Competitive Advantage. Free Press. ISBN 978-0-684-84146-5.
  2. Warf, Frederick P. Stutz, Barney (2007). The World Economy: Resources, Location, Trade and Development (5th ed.). Upper Saddle River: Pearson. ISBN 978-0132436892.
  3. Chacarbaghi; Lynch (1999), Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter 1980, p. 45
  4. Clulow, Val; Gerstman, Julie; Barry, Carol (1 January 2003). "The resource-based view and sustainable competitive advantage: the case of a financial services firm". Journal of European Industrial Training. 27 (5): 220–232. doi:10.1108/03090590310469605.
  5. Passemard; Calantone (2000), Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter 1980, p. 18
  6. Rijamampianina, Rasoava; Abratt, Russell; February, Yumiko (2003). "A framework for concentric diversification through sustainable competitive advantage". Management Decision. 41(4): 362. doi:10.1108/00251740310468031.
  7. Lau, Ronald S (1 January 2002). "Competitive factors and their relative importance in the US electronics and computer industries". International Journal of Operations & Production Management. 22 (1): 125–135. doi:10.1108/01443570210412105.
  8. Powell, Thomas C. (1 September 2001). "Competitive advantage: logical and philosophical considerations". Strategic Management Journal. 22 (9): 875–888. doi:10.1002/smj.173.
  9. "Porter's Generic Strategies: Choosing Your Route to Success". www.mindtools.com. Retrieved 2016-04-01.
  10. Jump up to:a b "Generic Competitive Strategies - strategy,levels, system, advantages, school, company, business, system". www.referenceforbusiness.com. Retrieved 2016-04-01.
  11. "Oxford Learning Lab - Watch it. Learn it. Badge it". www.oxlearn.com. Retrieved 2016-04-01.
  12. "Business Strategies for a Competitive Advantage". smallbusiness.chron.com. Retrieved 2016-04-01.
  13. Muilwijk, E. "Positioning". Intemarketing. Intemarketing. Retrieved 2016-09-18.
  14. Aaker, D. A.; Shansby, J. G. (1982). "Positioning Your Product". Business Horizons. 26: 56.
  15. Jump up to:a b c Gray, E. R.; Balmer, J. M. (1998). "Managing Corporate Image and Corporate Reputation". Long Range Planning. 31: 695–702. doi:10.1016/s0024-6301(98)00074-0.
  16. Alexander, A.; Martin, D. (2013). "Intermediaries for open innovation: A competence-based comparison of knowledge transfer offices practices". Technological Forecasting & Social Change. 80: 38–49. doi:10.1016/j.techfore.2012.07.013.
  17. Yang, C. (2015). "The integrated model of core competence and core capability". Total Quality Management. 26: 173–189. doi:10.1080/14783363.2013.820024.
  18. Jump up to:a b Hamel, G.; Prahalad, C. (1992). "How capabilities differ from core competences: The case of Honda". Harvard Business Review. 70: 66.

This information is provided under the Wikipedia Creative Common License. More updates coming soon.

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Jason Quey

I am the CEO and Founder of Growth Ramp. I enjoy helping high-growth startups on their journey from idea to scale.

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