Tuesday, August 30, 2011

Buffett on Widening the Moat

Warren Buffett wrote the following in the 2005 Berkshire Hathaway (BRKa) shareholder letter:

"Every day, in countless ways, the competitive position of each of our businesses grows either weaker or stronger. If we are delighting customers, eliminating unnecessary costs and improving our products and services, we gain strength. But if we treat customers with indifference or tolerate bloat, our businesses will wither. On a daily basis, the effects of our actions are imperceptible; cumulatively, though, their consequences are enormous. 

When our long-term competitive position improves as a result of these almost unnoticeable actions, we describe the phenomenon as 'widening the moat.' And doing that is essential if we are to have the kind of business we want a decade or two from now. We always, of course, hope to earn more money in the short-term. But when short-term and long-term conflict, widening the moat must take precedence. If a management makes bad decisions in order to hit short-term earnings targets, and consequently gets behind the eight-ball in terms of costs, customer satisfaction or brand strength, no amount of subsequent brilliance will overcome the damage that has been inflicted."

The primary responsibility of a business executive is to understand the risks and threats to a franchise then take proactive action to protect and build the competitive advantage(s). An executive management team in place that understands their moat widening responsibilities improves long-term returns. Here's how Buffett explained it at the 2000 Berkshire shareholder meeting:

"We think in terms of moats that are impossible to cross, and tell our managers to widen their moat every year, even if profits do not increase every year."

If done well, it ultimately reinforces or improves the core economics (return on capital) of the franchise leading to superior investor returns.

Unfortunately, separating those who get this from those who pay it lip service is not always easy to do.

Adam

Long position in BRKb

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