Why Moats Beat Management (Most of the Time)
A quick review of competitive moats and whether great management or a great business model is more important in the long-run.
Something I’ve been asking myself recently is what drives a company’s long-term success? The key question being whether a company’s success is a function of the visionary leadership of its executives, or the structural advantages embedded in its business model?
In all my reading in and around capital markets and investments, I’ve found that while investors also often wrestle with this question, the data reveals a surprising answer: Moats—those durable competitive advantages that enable companies to fend off competitors—frequently outperform great management in delivering sustained financial results.
If you had asked me before seeing the data, I would’ve bet that great management and leadership of organizations would be enough to trump slight competitive advantages in rival businesses. I guess that’s why I’m not a betting man…
What is a moat?
Morningstar defines an economic moat as a company’s ability to maintain a competitive advantage over its peers and protect its profitability. These advantages often fall into categories like:
Cost Leadership: Costco’s ability to operate on razor-thin margins makes it nearly impossible for competitors to match its prices.
Brand Power: Companies like Nike and Apple command deep customer loyalty, translating into pricing power and repeat business.
Network Effects: Platforms such as Visa and Microsoft grow stronger as more people use them, creating self-reinforcing ecosystems.
Moats are enduring. They’re built into the DNA of a business, making them difficult for competitors to replicate. As Morningstar aptly states in this article:
“Even the best corporate leaders struggle to outmaneuver competitors in industries where durable cost advantages, brand power, or network effects create structural barriers.”
This durability makes moats a crucial factor in assessing long-term investment opportunities. Below is a wonderful graphic by Morningstar that highlights an important takeaway, however, which we’ll explore in more detail later in this newsletter - the idea that wide moats (i.e. business model prowess) combined with poor management tend to still outperform companies with great management but poor competitive dynamics.
Wide-Moat Stocks, Even With Poor or Standard Morningstar Capital Allocation Ratings, Have Outperformed All Others
Median annualized total return, Jan. 1, 2017 - Aug. 18, 2023
More granularly, the chart compares the performance of companies with varying combinations of economic moats (Wide, Narrow, or None) and management ratings (Exemplary, Poor, or Standard) over time.
Note that companies categorized as "Wide + Poor or Standard" exhibit higher performance compared to all other categories, including those rated as "None + Exemplary." This underscores the importance of durable competitive advantages in driving long-term financial success. While exemplary management can enhance performance, the structural advantages provided by a wide moat often outweigh the impact of management quality. This aligns with an investment philosophy that moats provide resilience and sustainability in value creation, even when leadership falters.
In essence, the chart reinforces the idea that moats are a more consistent driver of superior financial results than management excellence alone. It also suggests that while skilled management can amplify the benefits of a strong moat, it is no substitute for the enduring advantages of a wide-moat business.
Buffett on Moats
Warren Buffett, a longtime proponent of investing in companies with strong moats, describes them as “unassailable competitive advantages.” According to Buffett, the best businesses are those that can fend off competitors for decades, allowing them to grow earnings consistently.
Morningstar’s definition complements Buffett’s perspective by categorizing moats into five primary sources:
Intangible Assets: Brands, patents, or regulatory approvals that give companies pricing power or exclusivity.
Switching Costs: Barriers that make it costly or inconvenient for customers to switch to a competitor.
Network Effects: The value of a product or service increases as more people use it, creating a self-reinforcing loop.
Cost Advantages: Unique processes, economies of scale, or access to resources that allow for lower production costs.
Efficient Scale: Dominance in a niche market where competitors find it unattractive to enter.
Where Management & Human Capital Management Fits In
While moats are critical, they’re not self-sustaining. Strong management ensures a company can fully leverage its competitive edge, turning structural advantages into operational results.
Key ways management enhances a moat:
Execution and Strategy: Visionary leaders like Satya Nadella at Microsoft have expanded moats by steering companies into new markets while strengthening core advantages - just look at the company’s investments in AI over the last few years.
Talent as a Multiplier: Companies with strong human capital strategies often reinforce their moats through better service, innovation, and efficiency.
Consider two examples:
Starbucks: Its moat lies in its global brand and scale, but investments in employee benefits and training enhance the customer experience, fortifying its competitive edge.
Tesla: While Elon Musk’s leadership doesn’t fit the traditional definition of a moat, his ability to drive innovation creates a dynamic advantage that amplifies Tesla’s competitive positioning.
Why Do Moats Win (Over Talent)
Despite the importance of management, structural advantages often outlast even the most capable leaders. Here’s why:
Resilience: Moats provide a buffer against poor management decisions. A strong brand, for example, can sustain customer loyalty even during periods of subpar leadership.
Limits of Leadership: Exceptional management without a moat can only go so far before competitors catch up or market conditions change.
Morningstar’s analysis supports this view:
“When forced to choose between management and moats, based on recent stock performance, moats win out.”
This insight underscores the enduring value of structural advantages in building long-term shareholder wealth.
A Framework for Evaluating Management and Moats
For investors, the sweet spot lies at the intersection of great management and durable moats. Here’s a practical framework for evaluating both:
Assess the Moat
What structural advantages protect the company from competition?
How durable are these advantages in the face of technological, economic, or regulatory changes?
Evaluate Management’s Role
Does leadership effectively exploit the moat to drive growth and profitability?
Are workforce strategies—such as training, employee engagement, and innovation—reinforcing the company’s competitive edge?
Look for Synergy
Does management actively strengthen the moat through strategic investments or operational excellence?
At the end of the day, I don’t believe that the debate between management and moats is binary. Instead, think of it as a partnership where moats provide the foundation for competitive strength and long-term profitability and where management maximizes the value of that foundation through effective strategy and execution.
I’ll argue that one cannot exist without the other. Which is a good thing for talent.
What a weird and wonderful world,
Interesting and fresh perspective