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Building Moats & Tents: Reinvesting for Success

Marketplace partnershipBlog

Losing Money for Fun & Profit

Amazon, famously, was never profitable – for decades, investors loved the fact that Amazon didn’t turn a profit. What a weird concept. What was Amazon doing to prevent themselves from being profitable?

There’s a long standing joke that if any division of Amazon was ever profitable, Jeff Bezos would fire the director for not spending enough money.

This wasn’t just a trueism, it’s an important part of Amazon’s business strategy – that many companies copy, but few of them succeed at.

So what was Amazon doing with all this money? They were building moats.

What is a Moat?

I want a business with a moat around it with a very valuable castle in the middle. And then I want the duke who’s in charge of that castle to be honest and hard-working and able. And then I want a big moat around the castle. – Warren Buffett

A Moat is a competitive advantage. More specifically, it’s a way that you, through your business practices, have managed to raise the barrier to entry for your competitors.

Take for example 2 day shipping. 2 day shipping is a moat. It’s difficult for any competitor to come along and match it.

By taking the money they earned from AWS and from their ecommerce business, Amazon built a hundreds of warehouses around the country.

Amazon is buying up shopping malls – which are perfectly positioned to fulfill to the suburbs of America. Amazon is building tents to get even closer so they can offer 1 day delivery.

Their investment in real estate across America is massive. The Atlantic estimates that Amazon’s owns 288 million square feet of real estate for its warehouses. That’s 6612 acres or 10.33 square miles – half the size of Manhattan Island.

Anyone trying to compete with Amazon would have to buy the equivalent of half of New York, NY to approach the amount of warehouse real estate Amazon owns.

Why Build a Moat?

The key to investing is … determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors. – Warren Buffet

Reinvesting money into your business to grow your business is nothing new. What Amazon specifically did was to invest their money into things that were capital and labor intensive.

A Barrier to Entry is a fixed cost that must be paid by any startup in order to compete with other startups in that space. An example of this is telecommunications – with all of the wire AT&T laid down to connect the phones of the world, it would be very difficult to compete with them. Even Google – who owns “72 million feet” of fiberoptic cable only offers internet in a few cities.

By building this network of warehouses, Amazon has taken something that has a theoretically low barrier to entry (starting an online store) and turned it into something nobody could compete with (an online store with 1 day delivery).

Identifying Your Moats

Moats are things that are hard to do. Building moats isn’t necessarily about being clever, it’s about growing the parts of your business that are hard to grow – because that’s where your competition won’t be able to keep up.

Here are some example moats.

Network Effects—Facebook

The more members you have, the more valuable the network. It would be incredibly difficult to launch a social network the size of Facebook’s. Each person on the platform adds value to the other people on the platform.

Big Data—Google

Google processes 3.5 billion searches each day. We tell Google everything about ourselves – when we’re feeling sick we look up symptoms, and when we want to relax we look up vacation destinations. With all this data, it would be impossible for a competitor to come along and improve on what Google does.

Economies of Scale—Amazon

The old engineering axiom is “fast, cheap, good – pick any two”. Everything is a compromise, except, it seems, when it comes to Amazon whose decades of experience selling us the right thing at the right time, at the right price, and delivering it quickly only seems to make them better and better at it.

Switching is Difficult—Apple

I talk to a lot of people in the Apple ecosystem who aren’t happy with the company’s latest phone offerings, but they’re locked in to Apple. As much as the new Google Pixel may be tempting, if they were to switch to Android, they’d lose all of their images (backed up in Apple’s cloud), all the music they’d purchased, all their apps and their ability to facetime with their friends. And Apple is a luxury brand – a status symbol that people will pay a premium for.

When trying to identify your moats, think about the levers that move the business. The things that were hard to do – where you maybe had a first-mover advantage and where you have a head-start on your competition. How can you maintain and grow that head start? What are areas where it would be difficult for your competitors to catch up to you? Those may be moats.

What Isn’t a Moat

One of the companies copying Amazon’s “don’t turn a profit” strategy is Uber, who loses 3 to 4 billion dollars a year. Simply spending money on your business does not automatically mean you have a moat. While they have a strong first-mover advantage (being the first ride sharing app in many cities) they don’t have many moats.

The barrier to entry (build an app) is relatively low, and drivers are willing to switch to whatever app will earn them the most money, which means they don’t have a strong network effect. It’s incredibly easy to just install a different app on your phone – switching is painless. So what is Uber spending their money on? Self driving cars.

Uber’s business model – offer a cheaper and more convenient cab service – isn’t sustainable. They’re effectively losing money on every ride & their drivers aren’t profiting either. This is business 101 – if the only thing you can compete on is price, you don’t have a real business model.

Perhaps one day – years from now – self driving cars will make the cab service less expensive to operate, but Uber is betting that they can lose billions of dollars every year until that happens. It’s just not sustainable, and until their self-driving technology is real and a real advantage they have over other companies, it’s not a moat.

Growing Your Moats

We tell our managers we want the moat widened every year. That doesn’t necessarily mean the profit will be more this year than it was last year because it won’t be sometimes. However, if the moat is widened every year, the business will do very well. – Warren Buffett

It’s not enough to have a moat – you need to continue to grow your moat.

Jeff Bezos decided that Amazon needed to offer 1 day shipping. Within months (if not weeks) Amazon was rolling out tents across America to act as warehouses – temporary structures that can serve this purpose until more durable structures can be built, increasing the size of Amazon’s moat.

Each year you need to push forward and think about the things your competitors are unable or unwilling to do. Are there any new areas where you can get a first-mover advantage and increase the size of your moat? Is there a way to grow the size of your existing moat?

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