My wife Sarah and I love playing board games. Since we sit in front of computer screens all day for work it’s a nice way to get away from electronics and go old school. One of our favorite board games is The Castles of Burgundy. Each player is the ruler of a small kingdom with the goal of expanding their kingdom by building out regions of cities, farms, castles and ships. Completing regions allows players to collect victory points and advance around the gameboard. The player with the most victory points at the end of the game wins. There’s a lot of strategy involved and the game takes about an hour to play. That’s why Castles is generally reserved for weekends and date nights when we can enjoy a cup of coffee or a glass of wine. The end of the game can get a little dicey as one player can prevent the other from completing a large region and collecting a lot of victory points; this is where strategy comes into play and it’s what gives one kingdom an advantage over another. I don’t like it when Sarah does this to me, but it’s all part of the game. It's about gaining a competitive advantage over your opponent.
In the business world Warren Buffett calls a company with a competitive advantage a “moat”. In medieval times the quickest path to wealth was to take over a castle. If the castle wasn’t surrounded by a moat it was difficult to defend. Attackers could simply walk in the front door and take control of the castle and all the wealth it controls. It’s the same with a business. It could have the best products or services in the world, but if it doesn’t have a moat to keep competitors out, it will see its market share and profits diminish rapidly.
When I was in my teens, I was a bowler without a lot of money. In those days bowling balls typically cost about $100. That’s a lot of money for a teenager making $3.75 per hour. I became friends with the owner of the pro shop. He was pretty busy drilling bowling balls and managing the shop, so he had little time to resurface bowling balls. Back then most bowling centers had wooden lanes that wore grooves in the bowling ball causing it to not roll true. You could bring your bowling ball to the pro shop and have the ball resurfaced and restored to its factory finish. The pro shop owner made a deal with me, he said for each ball I resurfaced, he would give me a $5 credit toward bowling equipment. I agreed and spent all my spare time (pun intended) resurfacing bowling balls. Over time I acquired an arsenal of over 12 bowling balls to deal with any lane condition from oily to extremely dry. Well, a year later my sweet gig came to a screeching halt when new management took over the pro shop. I was told my services were no longer needed and swift changes followed. They increased the prices of bowling balls and increased the resurfacing fee by $10-$15. Customers were not happy about the price increases and I wasn’t happy about losing my cushy job. I enjoyed restoring bowling balls to their original finish and the reaction I got when customers picked them up.
I fumed for a few days, then I decided to get even with the new owner. I pulled $500 out of my savings account and bought a resurfacing machine, sandpaper, wax and other materials. I set up shop in my parent’s basement and Flynner’s Spinner was in business. I was just a kid so I had no idea how much to charge so I took the pro shop’s new prices and cut them in half. Word spread quickly because customers knew I did a great job and my prices were more than fair. I had more work than I could handle. I would get home from school, get my homework done and resurface bowling balls until I had to go to my part-time job at Rite Aid. I was able to repay my loan to myself in just a couple of months.
Things were going great until one day I was bowling on the lane near the pro shop owner and his cronies. He yelled over to me and said, “if I see you taking any more business out of this place, I’ll turn you over to the state.” I didn’t know anything about starting a business, I guess I missed a few steps like having a business license. From that night on I made other arrangements to meet up with my customers.
The point of this story is the pro shop should’ve enjoyed a natural monopoly because it is the only bowling center for 20 miles and the pro shop was the only game in town. Most bowlers had a really good relationship with the original pro shop owner and had no need to go anywhere else. When new management came in and made abrupt changes many bowlers were willing to drive 20 miles or more to another pro shop to buy equipment and have bowling balls drilled, myself included.
So as you can see the pro shop once had a wide moat business, but ended up with a no moat business. A clueless kid attacked their castle and wiped out a portion of their business. Now, would you rather invest in a business that has a wide moat or no moat?
When we are looking for businesses to invest in, we want companies that will still be around 10-20 years from now. That’s why we are looking for high quality businesses with wide moats to protect their profit machines. Many new companies emerge with a unique product or service and are incredibly profitable. Competitors see all this new success and want a cut of the action so they develop similar products and services and attack the castle. There are five different types of moats that a company can build to prevent competitors from attacking their castle and protect their profits. I’ll cover the brand moat in this issue and we’ll discuss the others in future issues.
