Warren Buffett Can't Escape Unethical Strategic 'Moats'

Not all moats live up to Buffett's folksy image

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May 15, 2018
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A few days ago, fellow GuruFocus contributor John Engle asked the question:Â Are Warren Buffett’s Strategic ‘Moats’ Unethical?

Engle was commenting on the recent spat between Warren Buffett (Trades, Portfolio) and Elon Musk over the notion of business moats. As I have discussed previously, Musk started this argument before Buffett responded to the Tesla (TSLA, Financial) founder's attack on strategic moats, which he believes are "lame" and "sort of quaint in a vestigial way." After Buffett responded to Musk's assertations at the Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) meeting, Musk then continued the argument on Twitter, eventually making a claim that "moats are essentially unethical, sheltering oligopolies from the competition."


This isn't the first time Buffett's love of moats has been attacked. Berkshire Hathaway has been criticized for its business practices, which seemed to put profit over customers, particularly at its Clayton Homes division.

The key differences

In his article, Engle notes there's an essential distinction between moats and oligopolies. Specifically, he writes: "Moats are maintained through excellence of product or service while oligopolies are sustained through price-fixing and manufactured structural barriers to entry."

It could be argued that some of Buffett's businesses fall into the latter category.

The classic example of this is Buffett's Buffalo Evening News, which he originally purchased in 1977. For several years, this business struggled to compete with its primary competitor, Buffalo Courier-Express, but eventually, Buffett prevailed by launching a Sunday edition and finally taking over the entire market. You could argue the Buffalo Evening News built its moat by investing more in its content, but that would leave out a large part of the story. Buffett used a significant amount of money and influence for the rest of his empire to help transform the business, cut costs and fight legal battles. Trying to compete against this would certainly qualify as "manufactured structural barriers to entry."

Other businesses in the Buffett empire exhibit similar traits. Clayton Homes, for example, the largest builder of modular and manufactured homes in the United States, has been accused of relying on "predatory sales practices, exorbitant fees and interest rates that can exceed 15 percent, trapping many buyers in loans they can’t afford and in homes that are almost impossible to sell or refinance." Evidently, if the company were looking to expand its moat naturally, it would be trying to achieve the best reputation and results for customers rather than price gouging -- a tactic only the largest nonopoly businesses tend to get away with.

These are just two examples of the expansive Berkshire empire, and they are not representative of the whole business. Nevertheless, in recent years Buffett has been moving into industries such as railroads and utilities, which generally tend to exhibit qualities similar to oligopolies. BNSF has undoubtedly built structural barriers to entry around its operation by becoming one of the largest railroad companies in the United States.

Before Buffett's acquisition, the business was already well-known in the industry for running a highly efficient railroad, which certainly qualifies as building its moat. But the company also operates virtually unopposed in individual states, giving it room to charge whatever it fancies. Then there's Buffett's ownership of Texas utility firm Oncor. Utility companies are known around the world for dubious pricing practices, and it would be naive to believe Oncor is any different.

Difficult to avoid

As mentioned above, these are just a few of the many companies that make up the Berkshire Hathaway empire, and they are not representative of the whole group. However, they do show there is some truth to the statement moats can be unethical, especially in some industries and markets.

But this is not a problem exclusive to Berkshire Hathaway. Rather, it is more of a negative side to the business world. In a truly competitive environment, this would not be the case, but the world is not a perfect place. In some Industries, it is impossible to be entirely competitive.

Disclosure: The author owns no stocks mentioned.