During the past fortnight, two of the world's most public billionaires, Elon Musk and Warren Buffett (Trades, Portfolio), have become entangled in some sort of war of words. It all started on the Tesla first quarter earnings conference call, when Musk, responding to a question from analysts regarding the use of strategic "moats" responded:
"I think moats are lame ... They are like nice in a sort of quaint, vestigial way. If your only defense against invading armies is a moat, you will not last long. What matters is the pace of innovation, that is the fundamental determinant of competitiveness."
This was widely interpreted as a swipe at Buffett. The concept of a business moat has been a critical part of Buffett's investment strategy for decades, ever since he acquired See's Candies in 1972, moving away from his deep value mentality, to buying quality at a reasonable price. Buffett has remained committed to the most principal throughout his career for the simple fact that it works. However, over the past decade, there has been a substantial shift in the investment landscape where moats are no longer as safe as they once were because the pace of innovation has picked up and consumer tastes are changing.
Companies are now having to invest more than ever before to remain ahead of the game; they can no longer rely on a strong brand to give excessive profit margins. This is why, to a certain extent, Musk's comments are correct, and when asked what he thought about the Tesla founder's statement, Buffett gave the following response:
"Certainly you should be working on improving your moat and defending your own moat all the time. And Elon may turn things upside down in some areas. I don’t think he’d want to take us on in candy. And we’ve got some other businesses that wouldn’t be so easy. You can look at something like Garanimals … It won’t be technology that takes away the business in Garanimals—maybe something else that catches the young kids’ fantasy or something. But there are some pretty good moats around."
Charlie Munger (Trades, Portfolio) then added:
"Elon says a conventional moat is quaint, and that’s true of a puddle of water. And he says that the best moat would be to have a big competitive position, and that is also right. It’s ridiculous. Warren does not intend to build an actual moat. Even though they’re quaint."Â
These measured responses from the Berkshire Hathaway duo attracted an interesting reaction from Musk. Musk announced on Twitter, "I’m starting a candy company, and it’s going to be amazing." A few hours later he referenced Buffett directly in a tweet saying, "I’m going to build a moat & fill it w candy. Warren B will not be able to resist investing! Berkshire Hathaway kryptonite."
The tone of Musk's tweets suggests that he was joking about the whole debate, but it would be interesting to see what would happen to See's competitive advantage if he did carry through. So far, merchandise with a link to Musk's empire has performed exceptionally well. Fans have been eager to snap up products related to the billionaire's forward-thinking, futurist empire. And in some respects, the Musk empire has a moat itself. Tesla has a cult following, much like customers who continually buy See's candies or Coke's cola.
Buffett is also well-aware that a company has to work hard to maintain its reputation and moat. It cannot just sit back and wait for the cash to roll in. Indeed, the Oracle of Omaha said the following at the Berkshire Hathaway annual meeting held in the year 2000:
"So we think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the primary criterion of a great business. And 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 sometimes be. However, if the moat is widened every year, the business will do very well. When we see a moat that's tenuous in any way – it's just too risky. We don't know how to evaluate that. And, therefore, we leave it alone."
Buffett's goal is to make sure the moat exists and that it's getting deeper all the time, something Musk seems to have overlooked:
"Things are all the time changing that moat in one direction or another. Ten years from now you can see the difference. Our managers of the businesses we run, I’ve got one message to them, which is to widen the moat. And we want to throw crocodiles and sharks and everything else, gators, I guess, into the moat to keep away competitors. And that comes about through service, and it comes about through quality of a product, it comes about through cost, it comes about sometimes through patents, it comes about through real estate location."
Disclosure: The author owns no share mentioned.
