Why big moats can be bad

Large competitive moats play an important roll in determining the current and future success of a business. Moats are barriers to entry that protect the economic castle—from both new entrants, or expansion by current competitors. So the bigger the moat, the better the business, right? For the current and very near future, yes. But huge competitive advantages can become disadvantages when they lead companies to become complacent about their customers and potential alternatives to their product.

On the one hand, you have Wal-Mart and Coca-Cola—companies where consumer preference plays a large role. Wal-Mart has economies of scale that result in lower costs—probably the biggest competitive advantage in all of retail. But as the old saying goes, “retail is detail” and they still have to work hard to get the customer experience right (at least for their price point). If they don’t, competitors like Target and the dollar stores are more than willing to pick up new business.

Coca-Cola also has seemingly large advantages: a powerful brand name due to strong consumer habit and share of mind, plus large economies of scale in global marketing and distribution. Coca-Cola-owned brands account for 3% of every beverage consumed in the world today. But consumer preference still drives this market share, and a single slip-up (like this) can drive customers to the also-dominate #2 in the market, Pepsi.

On the other hand, you have companies with extremely wide moats like Microsoft and Ebay. They essentially have a lock on most of their customers because of high switching costs or strong network effects. Ten years ago, if you used their products and wanted to switch, it would be very difficult. Among other reasons, I think that led them to skimp on product quality and customer experience. There were product updates and improvements, but little innovation compared to alternatives. Why upset the apple cart when people are essentially forced to use your product?

The details matter!

Having a powerful lock on customers can lull companies into complacency. By the time they realize customers  have a good alternative or their business model is being disrupted, it may be too late. For companies who have big competitors or have to constantly cater to customers, it’s easier not to fall into that trap. So if you have the luxury of running or investing in a business with a strong lock on its customer base, remember to sweat the details. Customers will always eventually have an alternative.

One thought on “Why big moats can be bad

  1. Microsoft products are awful. Where do you draw the line though? If I’m a monopoly, it’s in my best interest to push down competition. In Microsoft’s case, this might be alternatives to the Office Suite, or simply Excel over Lotus 123. At some point, the customers catch up– say Google Docs or any of the other Office compatible alternatives. These alternatives “creatively destroy” your cash cow, yet at what point would you decide as a manager to sacrifice your own cow before your competitors do? I think it’s a tough decision. I guess what I’m saying is how much can you say it’s motivated by complacency? Perhaps it’s more a matter of risk aversion?

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