stuck in the moat

Warren Buffet's worst joke

If someone ever pitches the book “the history of the world in 1000 metaphors”, there will definitely be a place for the 2007 letter from Warren Buffett to shareholders of Berkshire Hathaway.  If I close my eyes and pretend my speaking voice is considerably more broadcast-friendly than it actually is, I can hear myself droning away on Radio 4, explaining that one folksy quip in that letter led to decades of economic stagnation, as the middle class of England sips tea and says “oh I might listen to that later”.

“A truly great business must have an enduring ‘moat’ that protects excellent Returns on Invested Capital”.

I don’t know if this ought to be in a miniseries “Buffett as miseducator”, or whether he meant it, but the concept of a “moat” really caught on like nobody’s business, and it’s been an absolute disaster for the Western world.

Ever since this concept caught on, everyone has been mad for getting a “moat” round their business, or at least talking as if they had one.  But the trouble is that the original companies Buffett was talking about were things like Coca-Cola or Disney, where the “moat” was the fact that nobody else could make such a great product that everyone wanted.  It’s certainly true that he also meant it to refer to companies with built-in regulatory protection or natural monopolies, but the main focus was on things that had a kind of intangible asset.

I say “intangible asset” there rather than “intellectual property” because when you mention IP everyone immediately starts thinking about legal protection and it’s not really about that.  To take an example from my own recent work, the folding hinge mechanism of the Brompton bicycle is long since out of patent.  They have a few trademarks on the general shape and sweep of the thing, but there’s really nothing to stop you making a load of Brompton-like bikes … except that you don’t really know how to, you don’t have a load of specifically designed and programmed Brompton-making machines and you can’t recruit the services of specialist welders (brazers) because nobody else trains them.  So you’d be better off not bothering.  This is the good sort of moat; it’s really just a statement that “increasing returns from specialisation are so big that nobody else can keep up”.

What happened, though, was that a lot of people who didn’t fancy the hard yards of creating a big intangible asset thought that they could do a “moat” on the cheap, by hiring some lawyers, consolidating an industry through financial engineering or trying to lock consumers into proprietary formats.  Ever since the Buffett letter, an ungodly amount of management effort and talent has gone into trying to earn “excellent returns on capital” not by continuing to improve the product but rather by trying to create conditions which allow you to go on charging a premium price for the same thing.

Obviously, other things were going on in the world in 2007, but it is interesting that this management fad coincided with a disastrous slowdown in productivity.  Jonathan Tepper makes the case in “The Myth of Capitalism: Monopolies and the Death of Competition” that it’s causal.  Back in the olden days, it was considered that a major problem of monopoly was “x-inefficiency”, the tendency of monopolies to lay back and enjoy an easy life because they weren’t under threat.  Maybe it turned out that when you took that waste and managerial nest-building, and turned it into a financial dividend, the underlying problem didn’t go away.

I’d be tempted to switch the metaphor.  When you hear someone talk about their “moat”, mentally replace it with something like “our subscription system and proprietary interface mean that our return on capital is protected by a strong Berlin Wall, preventing our customers from getting out to a freer society and forcing them to consume our inferior products for lack of alternative”.