Warren Buffett first coined the phrase ‘economic moat’ as a way of summing up how robust a firm is in the long term. In essence, this is the firm’s strength and ability to withstand economic headwinds.
Harvard professor Michael Porter came up with a similar idea when he mooted the concept that there are five key competitive forces that act on a firm. The better a firm is at dealing with them, the wider its moat.
The first is competition – the fewer firms that operate in a sector, the stronger each will be. The next is barriers to entry – the harder it is for new firms to enter the market, the better. These barriers may come in the form of regulatory hurdles or high capital requirements. The third force is the power of suppliers and the fourth is the power of customers – if the firm relies too heavily on a single one it is put at a competitive disadvantage. Finally, there is the threat of substitutes – if a firm’s product can be rendered obsolete too easily, its economic moat is too narrow.