# Wide Economic Moat: Meaning, How It Works, Sources

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> **Definition**
>
> A wide economic moat is a competitive advantage a company has that protects its market share from competitors.

## What Is a Wide Economic Moat?

The term wide economic moat refers to the [competitive advantage](https://www.investopedia.com/terms/c/competitive_advantage.asp) that protects a company's place in the market over the long term. Companies with a wide economic moat make it difficult for their rivals to wear down their market share. The term was popularized by [Warren Buffett](https://www.investopedia.com/articles/01/071801.asp) and is derived from the water-filled moats that surrounded medieval castles. Wide economic moats can be caused by several factors, including high barriers to entry.  

### Key Takeaways

*   An economic moat is a distinct advantage a company has over its competitors that allows it to protect its market share and profitability.
*   A wide economic moat is difficult to mimic or duplicate and creates an effective barrier against competition from other firms.
*   Companies with a wide economic moat can generate large amounts of free cash flow and have a track record of strong returns.

## Understanding Wide Economic Moats

As noted above, the term economic moat was coined by [Berkshire Hathaway's](https://www.investopedia.com/terms/b/berkshire-hathaway.asp) Warren Buffett. It refers to a company's ability to maintain a competitive advantage to protect its long-term profits and [market share](https://www.investopedia.com/terms/m/marketshare.asp) from competing firms. Just like a medieval castle, the moat serves to protect those inside the fortress and their riches from outsiders.

Businesses with at least one factor of [Porter's 5 forces](https://www.investopedia.com/terms/p/porter.asp) model would possess a wide economic moat. For example, a business that holds an exclusive patent for the creation of a miracle drug would effectively keep potential competitors out of its business. Having few or no competitors would allow the company to continually generate high levels of profit.

A company that exists in a business where the [startup costs](https://www.investopedia.com/articles/pf/09/business-startup-costs.asp) are prohibitive for small entrants would also have a wide moat. There are several other ways in which a company creates an economic moat that allows it to have a significant advantage over its competitors. Some of the most common reasons behind economic moats are explained below.  

> **Fast Fact**
>
> The premise of an economic moat is that a wider moat makes it more difficult for an invader to reach the castle. Similarly, when a company has a wider moat, its competition may find it challenging to eat away at its market share.

## How to Establish Wide Economic Moats

Companies have several ways they can establish (wide) economic moats to retain market share. This may make it difficult for the competition to steal customers and eat away at [revenue](https://www.investopedia.com/terms/r/revenue.asp). Let's look at some of these in more detail.

### High Barriers to Entry

High [barriers to entry](https://www.investopedia.com/terms/b/barrierstoentry.asp) can limit competition within an industry. These factors can be related to situational or economic, or they may be put up by the dominant force in the market.

Economic barriers to entry often include things like tax laws and regulatory hurdles. High corporate or business taxes and [red tape](https://www.investopedia.com/terms/b/bureaucracy.asp) can make it challenging for new players to (want to) enter the market. This can provide existing businesses with a form of protection from new competition. Higher startup costs can also deter future participants in the sector.

Other factors that prevent new companies from entering the market include:

*   **Pricing:** A business that can keep its operating costs low and its sales high can undercut its competition by lowering its prices and keeping rivals at bay. Walmart ([WMT](https://www.investopedia.com/markets/quote?tvwidgetsymbol=WMT)) is a good example. It has an immense volume of sales and negotiates low prices with its suppliers, resulting in low-cost products in its stores that are hard to replicate by its competitors.
*   **Switching Costs:** This phenomenon makes it very time-consuming and expensive for consumers to switch products or brands. Autodesk ([ADSK](https://www.investopedia.com/markets/quote?tvwidgetsymbol=ADSK)) offers various software solutions for engineers and designers that are very difficult to learn. Once an Autodesk customer starts using its software, he is unlikely to switch, allowing Autodesk to charge premium prices for its products.  
    

### Intangible Assets

[Intangible assets](https://www.investopedia.com/terms/i/intangibleasset.asp) are any proprietary assets that a company has that can't be touched but can significantly impact sales. This includes things like proprietary technology, patents, brands, and licenses that allow a company to protect its production process and charge premium prices.

While brands are typically derived from superior product offerings and marketing, [patents](https://www.investopedia.com/terms/p/patent.asp) are obtained as a result of companies' filings with governments to protect know-how for a specific period, typically 20 years. For instance, pharmaceutical companies earn high profits due to patented drugs after spending billions on [research and development (R&D)](https://www.investopedia.com/terms/r/randd.asp).

### Efficient Scale

Efficient scale arises when a particular market is best served by a limited number of companies, giving them near-[monopoly](https://www.investopedia.com/terms/m/monopoly.asp) statuses. Utility firms are examples of companies with an efficient scale that is necessary to serve electricity and water to their customers in a single geographic area. Building a second utility company in the same area would be too costly and inefficient.  

### The Network Effect

[The network effect](https://www.investopedia.com/terms/n/network-effect.asp) can further fortify or widen a company's economic moat by making its products more valuable when more people use them. One example of a network effect is online marketplaces such as Amazon ([AMZN](https://www.investopedia.com/markets/quote?tvwidgetsymbol=AMZN)) and eBay ([EBAY](https://www.investopedia.com/markets/quote?tvwidgetsymbol=EBAY)), which are widely popular among consumers because of the large number of people buying and selling various products through their platforms.

## Benefits of Wide Economic Moat

The obvious benefit of having a wide economic moat is that the company can keep its rivals at bay. This means that the company remains a dominant force in the marketplace and retains its market share. Being able to maintain or widen a moat can also increase a company's [brand value](https://www.investopedia.com/articles/financial-theory/11/branding-ultimate-economic-moat.asp). This is very important for companies that are heavily invested in a brand, such as Apple's iPhones.

Economic moats can also benefit other stakeholders. For instance, companies that have a wide economic moat are better equipped to lower prices. This can provide a major advantage to consumers. Paying less for a product or service gives people more money in their pocket for other things, including savings.

[Investors](https://www.investopedia.com/terms/i/investor.asp) are also in a position to gain from companies with wide economic moats. Companies can increase their cash flow and can guarantee [returns](https://www.investopedia.com/terms/r/return.asp) for their investors by narrowing out other players by creating a competitive advantage. These returns can be multiplied if businesses can maintain and expand a durable economic moat.

## How Does an Economic Moat Help a Company?

An economic moat provides a company with a certain level of protection from its competitors. Put simply, it's a competitive advantage that prevents other players from stealing market share, sales, and consumers from a company. Companies can create economic moats through competitive pricing and keeping costs low, by establishing popular brands, and through intangible assets.

## What Is a Competitive Advantage?

A competitive advantage is a set of conditions or circumstances that give a company an edge over its rivals—usually by producing superior products and services compared to its competition. Having a competitive advantage can give a company more market share and higher revenues as it serves a certain part of the market better than other companies.

## Are There Any Disadvantages Associated with Economic Moats?

While advantageous, there may also be some drawbacks that come with economic moats. It often costs companies a lot of money to position themselves as a key player in the market. This may result in expensive goods and services. Another disadvantage may occur when consumers begin to expect a lot from the dominant industry players. This is especially true when consumers want fair pricing, a certain quality of goods and services, and quick delivery times.

## The Bottom Line

An economic moat is a competitive advantage that companies have over their rivals. It allows them to protect their market share and keep their competitors at bay. While it certainly has it advantages, there are certain drawbacks to having an economic moat. First, it creates high expectations from customers, especially when it comes to pricing and delivery times. It also means that the quality of a company's goods and services must meet the demands of consumers.

> **Article Sources**
>
> 1.  Yahoo Finance. "[Warren Buffett Explains His Moat Principle](https://finance.yahoo.com/news/warren-buffett-explains-moat-principle-164442359.html)."